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Summary of the price system and the theory of the firm
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Summarised part of the price system and the theory of the firm
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the firm to get 51% of the total and therefore have control of the business. A mergeroften has the same result, a new larger legal entity, but the name implies less of a
struggle and that both parties have agreed to the action. Mergers may be more
numerous when there is a downturn in the economy or when there is a shrinking
market and firms are left with excessive productive capacity.
Diversification is another method of growth where a firm produces a range of
different products.
Diversification: Where a firm grows through the production or sale of a wide range
of different products.
Integration
Integration could be through:
● A merger whereby two firms agree to join up with each other
● Acquisition or purchase whereby one firm takes over control of another.
Horizontal integration is a process or strategy used by businesses to strengthen their
position in an industry. The prime motive for this is to benefit from economies of
scale.
Horizontal integration: Where a firm merges or acquires another in the same line of
business.
Vertical integration: Where a firm grows by producing forwards or backwards in its
supply chain.
Cartels
A cartel is a formal agreement between member firms in an industry to limit
competition. The agreement may involve fixing the quantity to be produced by each
member or fixing the price for which the product is sold. OPEC is the best example
of one with 12 members.
The long-term survival or cartels depend on the high barriers to entry. Threats to
cartels include:
● The possibility of a price war, whereby one firm breaks rank in pursuit of a
larger market share.
● If some members have higher costs than others, resulting in fewer profits
because of the agreed fixed price.
● If there is no dominant member that has the power to control others.
, ● Legal obstacles such as in the EU or the USA where cartels are illegal since
they restrict competition and do not have the consumers’ best interests in
mind.
Differing objectives of a firm
Profit maximisation
We assume that a firm’s only objective is to maximise profits, even though this is not
always the case. A firm making the minimum level of profit is assumed to be
producing at the break-even point and does not make abnormal profit. However,
businesses take risks to earn abnormal profits.
Profit margin
MC
Cost
Loss on each
and
successive unit
revenu
e
MC>MR
MR>MC
Profit
maximisation
output:
MC=MR
MR
0
Q
Output
There may be various reasons why firms do not operate at the profit maximisation
output:
● It is difficult to identify this output. The firm may simply work out the
average total cost and then add on a standard profit margin in order to
determine the selling price. This cost-plus pricing technique may not result in
maximum profit.
● Short-term profit maximisation may not be in the long-term aims of the firm
since:
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