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Objectives of Firms

A2 Unit 3 Economics
by

Phil Smith

on 4 October 2011

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Transcript of Objectives of Firms

Theory of the firm Costs An economic perspective of business Revenues Profit Market
structure Perfect
competition Monopoly Monopsony Monopolistic
Competition Oligopoly Kinked
demand Game theory Contestable
markets "The opportunity cost of production" Imputed cost Labour Financial capital Depreciation reputation Fixed cost Does not vary with output e.g. cost of advertising
no matter its affect on
your sales often capital goods Variable cost varies with output more steel produced
more iron ore needed In the long run, all
are variable costs Total cost
TFC+TVC=TC

Average cost
TC/Q=AC

Marginal cost
ΔTC/ΔQ=MC All products Each product One more Short Run Some factor inputs are fixed supply. Long Run All inputs are variable. Very Long Run Even technologies can change. Short run at
differen't levels
of production "A firm's reciepts of money from the sale of goods and services over a time period" Total Revenue
Q*P=TR

Average Revenue
TR/Q=AR

Marginal Revenue
ΔTR/ΔQ=MR TR MR=AR When price is constant Sales Average Revenue Total Revenue Marginal revenue 1 2 3 4 5 6 7 8 9 10 5 5 5 5 5 5 5 5 5 5 5 10 15 20 25 30 35 40 45 50 5 5 5 5 5 5 5 5 5 Sales Average Revenue Total Revenue Marginal revenue 1 2 3 4 5 6 7 8 9 10 30 27 24 21 18 15 12 9 6 3 30 54 72 84 90 90 84 72 54 30 24 18 12 6 0 -6 -12 -18 -24 When price is dropped
or higher sales TR MR AR "profit is the difference between revenue and costs" Output Marginal Revenue Marginal Cost 1 2 3 4 5 6 7 8 9 25 25 25 25 25 25 25 25 25 35 26 14 15 16 18 25 34 47 -10 -1 11 10 9 8 0 -9 Δprofit -22 Normal Profit The revenue is equal to
the total costs of production Profit is not the same as in
business In economics we include opportunity cost Abnormal Profit Profit more than normal profit Supernomal profit MC=MR Profit Maximisation Where MC=MR, marginal profit is greatest. MR MC An increase in Costs of production
leading to decreased profit maximising output MR MC1 MC2 The opposite is true
for an increase in MR Short run shut down points Sometimes a firm will be operating at a loss
but less of a loss than that if it shut down.
This is due to fixed costs which can't be stopped in the short run. What are firms trying to achieve? Profit max
Revenue max
sales max
ethical objectives AR MR AC MC Profit max MC=MR Objectives
of firms AR MR AC MC Revenue max MR=AR AR MR AC MC Sales max AC=AR Who influences the decisions? Shareholders
Directors
Workers
The state
Consumers The number of firms in
the market and their size The number of firms
that might enter The ease of entry Variety of goods Symmetry of information Knock on effects Characteristics Monopoly There is only one supplier in the market Oligopoly There are a few large suppliers Perfect competition Large number of small suppliers which can't dominate the market Market
Concentration Barriers to Entry Capital Costs Sunk Costs Scale Economies Natural Cost Advantages Legal Barriers Marketing Barriers Limit Pricing Anti-competitive Practices Homogeneity and Branding In some markets the products are almost identical other than the branding Advertising can become more important than product quality If we have perfect information then all firms and consumers have access to all knows knowledge necessary to make the best products and the best price for them And consumers would know the differences between different firms products and the cheapest vendor to buy from Lazy consumers and firms could still not know though Interrelationships within markets Independent Interdependent Actions of one firm are unlikely to have a significant impact on another firm More common in with a few large firms-the actions of a firm will affect others High Levels of Competition Many buyers and sellers of equal influence.
They are said to be price takers.
There is freedom of entry to and exit from the industry.
Buyers and sellers have perfect knowledge.
All firms produce a homogenous product. Agriculture is perhaps the best example Supply and demand One assumption of perfect competition is that there are many small firms and buyers.


This means that a shift in supply or demand by one or few firms/buyers would have little to no effect on the overall equilibrium. therefore any firm could increase its production as it liked and any buyer could increase their demand as they liked without it affecting others D=AR=MR Long Run equilibrium MC AC D=MR=AR There will be no firms with supernormal or subnormal profits.

Those firms that made a loss in the short run would leave the market.

Any profits would attract more firms that erode that profit. Short Run equilibrium MC AC D=MR=AR In perfect competition firms are profit maximisers.

It is possible for them to make supernormal or subnormal profits.

They still can not set the price. There is only one firm in the industry - the monopolist
Barriers to entry prevent new firms from entering the market
The monopolist is a short run profit maximiser
their power comes from barriers to entry; most commonly capital costs and exclusivity of product. Discriminating monopoly Some potential buyers are prepared to pay more for a product than others and at times a monoplist can PRICE DISCRIMINATE between different buyers. Time Place Income It must face different deman curves from the separate groups or else the exercise is useless. It may vary price according to the location of the buyer. The same car can be bought at different prices in different countries of the EU. It may be able to split up consumers into income groups, charging a high price to those with high incomes and a low price to those with lower incomes. Examples of this can be found in the medical practice and amongst lawyers. Demand Grouping Separatism It may charge a different price at different times of the day or week, as do the electricity distribution companies or rail companies It must be able to split the market into distinct groups It must be able to keep the markets separate so buyers from the high priced market don't buy from the cheaper one Can consumers benefit from price discrimination? Firms use price discrimination to increase their profit, however sometimes consumers can benefit.

Some customers will be winners and otheres loses. Take the example of a monoplist which, without discriminating, would set a price of £10 per unit. When discriminatingl, it sets two prices, on £15 and one £8. Customers who pay £15 lose out, but customers who pay only £8 are gainers. Some of these customers are ones who would otherise have paid £10. Others are customers who would not have bought the product at all at £10.

In some cases, a monopolist would not supply at a profit maximising single price because it would make a loss. Its average revenue curve would be above its average cost curve at every level of output, but by price discriminating it might be able to raise revenues to a point at which average cost at least equalled average revenue. When there is only one buyer in the market Similar and opposite to monopoly but rarer Network rail in the UK dominates the market for purchase of rail track maintenance.
The government dominates the market for the hiring of teachers.

For the purpose of this unit they are assumed to be profit maximisers.
So they minimise costs by paying their suppliers the lowest possible price. Costs and benefits Monopsonist Suppliers customers The monopsonist gains higher profits by being able to buy at lower prices. This reduces its costs of production and is likely to lead to an increase in overall output because of a shift downwards in marginal cost curve. Note that whilst overall output is likely to increase, supply of inputs over which the firm has mospsony power will fall The impact on cusstomers depends on a variety of factors. Part of the lower costs the monopsonist is likely to be passed on to customers in lower prices. On the other hand, there may be restrictions in supply. The extet to which supply to customers will fall depends upton the price elasticity of supply in the market in which the monopsonist is the buyer. For example, if supply is highly price inelastic there willl be little fal in supply Suppliers are likely to lose out from a monopsony. Prices paid for their goods or services will faill. If it is farmers suppplying a supermarket chain, they will seee their prices fall. If it is workers supplying their services to a monopsony buyer of their labour, they will see their wages fall. Low prices will lead to less being supplied. In the case of farmers supplying a monopsonist supermarket chain, some farmers will switch out of producing one product and into another. Some farmers may be forced out of the market altogether A form of
Imperfect competition Competition exists because there are at least twoo firms in the industry.
Competition is impoerfect because firms sell products which are not identical to the productgs of rival firms. monopolistic competition is an example of this Assumptions of monopolistic competition (very similar to perfect competition) There is a large number of buyers and sellers in the market, each of which is relatively small and acts independently. There are no barriers to enty Firms are short run profit maximisers Firms produce differeniated or non-homogenous goods Hotel trade
coah travel
furniture marking If a firm produces slightly exclusive products then it will not lose all of its customers to another company when it raises price. For this reason it has some ability to set prices. But because there are similar products it does not have full monopoly strength. Demand curve is therefore downward sloping but elastic because consumers are willing to switch to close substitutes. AC MC AR MR MC=MR
Because they are profit maximisers
MR=AC
Because competitive pressures mean a firm an not make abnormal profit The majority of imperfectly competitive markets are 'Concentrated' or 'oligopolistic'. A market dominated by a few large suppliers Market structure Supply in the industry must be concentraded in the hands of relatively few firms. Perhaps 80% dominated by 3, 4 or 5 firms There can still be a large percentage made up of very small firms Firms must be interdependent The actions of one large firm willl directly affect another large firm. If one firm tries to increase sales. Then it must be attempting to take away demand from another firm. There are barriers to entry If there were no barriers to entry, other firms would see the abnormal profits of the olygopolists and reduce their market share. Market Conduct Non-price comptition In perfectly competitive market, firms producing homogenous goods compete solely on price. In the short term factors like delivery might be slightly important but in the long run price would be all that matters. However in an imperfectly competitive market, price is often NOT the most important factor. They decide upon a MARKETING MIX The 4 Ps Product Price Promotion Place a niche in the product that may appeal to more customers Informing buyers that the good is on sale and presenting it in a favourable manner Price could be set above or below competitiong depending on the strategy employed Distribution Price rigidity
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