Lecture notes
Economics A* Notes
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- AQA
Lecture notes of 23 pages for the course Unit 1 ECON1 - Economics: Markets and Market Failure at AQA (Economics A* Notes)
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Perfect Competition, Imperfectly Competitive Markets and Monopoly5.1 Market Structures
● There is a range of market structures. The market structure is concerned with how
the market is organised.
DIGRAMA
● Each Market Structure is characterised by:
➔ The number of firms in the market: the more firms there are, the more
competitive the market is. This also included the extent of competition from
abroad.
➔ The degree of [product differentiation: the more different the products, the
less competitive the market. In a perfectly competitive marketer, the products
are homogeneous. Products can be differentiated using price, branding and
quality, This affects the cross price elasticity of demand.
➔ Ease of entry into the market: this is the number and degree of the barriers to
entry. Barriers to entry are designed to prevent new firms entering the market
profitably. This increases the producer surplus. The higher the barriers to
entry, the less competitive the market. Examples:
- Economies of scale
- Brand loyalty, which makes demand more inelastic. It is hard for new
firms to gain consumer loyalty, when one firm's brand name is already
so strong
- Controlling the important technologies in the market
- Having a strong reputation
- Backwards vertical integration, which controls supply means firms can
control the price they pay their suppliers. This makes it hard for new
firms to compete on price which is then a barrier to entry.
- Barriers to entry can be structural, where they arise due to differences
in production costs, strategic, where firms use different pricing
policies, such as undercutting another firm's price or statutory, where
patents protect a franchise. An example of this is a TV broadcasting
licence.
,5.2 The Objectives of Firms
● Profit is an important objective of most firms. Models that consider the traditional
theory of the firm are based upon the assumption that firms aim to maximise profits.
● Firms also have other objectives
● Profit is the difference between total revenue and tortola cost. It is the reward that
entrepreneurs yield when they take risks.
● Firms break even when TR = TC
● A firm's profit is the difference between TC and TR. A firm profit maximises when
they are operating at the price and output which derives the greatest profit. Profit
maximisation occurs when MC = MR. In other words, each extra unit produced gives
no extra loss or no extra revenue.
Diagram check
● Profits increase when MR > MC. Profit decreases when MC > MR.
● Some firms choose to profit maximise because:
- It provided greater wages and dividends for entrepreneurs
- Retained profits are a cheap source of finance which saves paying higher
interest rates on loans
- In the short run, the interests of the owners or shareholders are most
important, since they aim to maximise their gain from the company.
- Some firms might profit maximise in the long run since consumers do not like
rapid price changes in the short run so this will provide a stable price and
output
● PLCs are particularly keen to profit maximise, because they could lose their
shareholders if they do not receive a high dividend. They are more likely to have
short run profit maximisation as an objective because they need to keep their
shareholders happy.
The Reasons For and the Consequences of a Divorce of Ownership from Control
● The Principal Agent Problem: can be linked to theory of asymmetric information. This
is when the agent makes decisions for the principal but the agent is inclined to act in
their own interest rather than those of the principal. For example, shareholders and
, managers have different objectives which might conflict. Managers might choose to
make personal gain such as bonus rather than maximise the dividends of the
shareholders
● When an owner of a firm sells shares, they lose some of the control they had over
the firms. This could result in conflicting objectives between stakeholders in the firm.
If the manager is particularly good, they might require higher wages to keep them in
the firm. However, they also need to keep shareholders happy, since they are an
important source of investment. It is not always possible to give both the manager a
high salary and the shareholders large dividends, since funds are limited.
● When managers sell their shares, shareholders gain more control over the decisions
of the firm. This could give rise to shareholder activism. This could be to put pressure
on the management of the firm or to try and get higher dividends. For example,
Sainsburys shareholders objected the decision to give the chairman a £2.3 billion
bonus in 2004
Other Possible Objectives of a Firm
➔ Survival: some firms, especially new firms entering a competitive market,
might aim to simply survive in the market, This is a short term view. During
the periods of economic decline such as the 2008 financial crisis, when
consumer spending plummets, firms might have survival as their objective,
until there is economic growth again. Firms might aim to sell as much as
possible to keep their market position even if it is a loss in the short run.
➔ Growth: some firms might aim to increase the size of their firm. This could be
to take advantage of economies of scale, such as risk bearing or
technological. This would lower their average costs in the long run and make
them more profitable. Firms might grow by expanding their product range or
by merging or taking over existing firms. Large firms are also more able to
participate in research and development which might make them more
competitive and efficient in the long run.
➔ Increasing their market share: this helps increase the chance of survival in the
market and it can be achieved by maximising sales. For example, Amazon
aimed to increase their market share in the e-reader market by trying to sell
as many Kindles as possible. THey did this at a loss in the short run but they
gained customer loyalty and now they are a leading e-reader producer.
➔ Quality: firms aim to increase their competitiveness by improving their quality.
Firms may consider improving their customer service or the quality of the
good they produce. This could be achieved through innovation. If firms can
gain the reputation for high quality goof, they could potentially charge higher
prices since consumers might be willing to pay more for them.
➔ Maximising their sales revenue: revenue maximization occurs when MR=0. In
other words, each extra unit sold generates no extra revenue.
Diagram
At this point Q P1, the firm is operating at MR=0 where revenue is maximised.
The curve shows how the point of maximum total revenue is MR=0.
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