Edexcel Economics AS-level

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1 Edexcel Ecnmics AS-level Unit 3: Business Behaviur Tpic 1: The Firm and its Objectives 1.1 Objectives Ntes

2 Why sme firms tend t remain small and why thers grw The size f firms can be determined by: Ecnmies f scale relative t market size: Large firms might nly experience small ecnmies f scale cmpared t their size, since the extent f ecnmies f scale might be limited in that industry. This culd make their csts higher than firms which chse t stay smaller. Disecnmies f scale: Larger firms culd face high csts because they have grwn t quickly. There culd be pr rganisatin, x-inefficiency r because firms in large, frmal markets tend t have t pay higher wages. Small firms as mnplists: Small firms culd hld sme degree f mnply pwer, since they prvide a mre persnal, lcal service. Their pening hurs might suit a small twn, such as thse f a crner shp, and sme cnsumer might prefer making smaller purchases, than the larger nes expected at bigger stres. Small firms might als create a niche market, where they can use their relatively price inelastic demand t charge higher prices. An example culd be a small café ver a multinatinal crpratin. Prfit mtive: By grwing, firms get the pprtunity t earn higher prfits. Grwing als allws firms t take advantage f ecnmies f scale, prviding they d nt grw s large that they experience disecnmies f scale. Market pwer: large firms have mre dminance ver the market, which allws them t gain price setting pwers and discurage the entrance f new firms. They might als gain mnpsny pwer, which can allw them t buy their stck at a lwer price. Diversificatin: By grwing and expanding the prduct range, firms reduce their risk f making huge lsses, since they have areas f the market t fall back n. Owners: Managers f the firm might have the mtive f larger bnuses, mre hlidays r mre leisure time, which encurages them t expand the firm. Distinctin between public and private sectr rganisatins Public sectr:

3 This is when the gvernment has cntrl f an industry, such as the NHS. The railway industry in the UK was natinalised after 1945, s it became part f the public sectr. There culd be natural mnplies in the public sectr. Fr example, nly ne firm will prvide water because it is inefficient t have multiple sets f water pipes. Sme public sectr industries yield strng psitive externalities. Fr example, by using public transprt, cngestin and pllutin are reduced. Public sectr industries have different bjectives t private sectr industries, which are mainly prfit driven. Scial welfare might be a pririty f a public sectr industry. It culd als lead t a fairer distributin f resurces. Private sectr: This is when a firm is left t the free market and private individuals. Fr example, British Airways is a private sectr firm. Free market ecnmists will argue that the private sectr gives firms incentives t perate efficiently, which increases ecnmic welfare. Firms have t prduce the gds and services cnsumers want, which increases allcative efficiency and might mean gds and services are f a higher quality. Cmpetitin might als result in lwer prices. This is because firms perating n the free market have a prfit incentive, which public sectr firms d nt. Distinctin between prfit and nt-fr-prfit rganisatins A prfit rganisatin aims t maximise the financial benefit f its sharehlders and wners. The gal f the rganisatin is t earn maximum prfits. A nt-fr-prfit rganisatin has a gal which aims t maximise scial welfare. They can make prfits, but they cannt be used fr anything apart frm this gal and the peratin f the rganisatin. Significance f the divrce f wnership frm cntrl: the principalagent prblem The principal-agent prblem can be linked t the thery f asymmetric infrmatin. This is when the agent makes decisins fr the principal, but the agent is inclined t act in their wn interests, rather than thse f the principal. Fr example, sharehlders and managers have different bjectives which might cnflict. Managers might chse t make a persnal gain, such as a bnus, rather than maximise the dividends f the sharehlders.

4 When an wner f a firm sells shares, they lse sme f the cntrl they had ver the firm. This culd result in cnflicting bjectives between different stakehlders in the firm. If the manager is particularly gd, they might require higher wages t keep them in the firm. Hwever, they als need t keep sharehlders happy, since they are an imprtant surce f investment. It is nt always pssible t give bth the manager a high salary and the sharehlders large dividends, since funds are limited. Different business bjectives: Prfit maximisatin Prfit is an imprtant bjective f mst firms. Mdels that cnsider the traditinal thery f the firm are based upn the assumptin that firms aim t maximise prfits. Hwever, firms can have ther bjectives which affect hw they behave. Prfit is the difference between ttal revenue and ttal cst. It is the reward that entrepreneurs yield when they take risks. Firms break even when TR = TC. A firm s prfit is the difference between its ttal revenue (TR) and ttal csts (TC). A firm prfit maximises when they are perating at the price and utput which derives the greatest prfit. Prfit maximisatin ccurs where marginal cst (MC) = marginal revenue (MR). In ther wrds, each extra unit prduced gives n extra lss r n extra revenue.

5 Prfits increase when MR > MC. Prfits decrease when MC > MR. Sme firms chse t prfit maximise because: It prvides greater wages and dividends fr entrepreneurs Retained prfits are a cheap surce f finance, which saves paying high interest rates n lans In the shrt run, the interests f the wners r sharehlders are mst imprtant, since they aim t maximise their gain frm the cmpany. Sme firms might prfit maximise in the lng run since cnsumers d nt like rapid price changes in the shrt run, s this will prvide a stable price and utput. PLCs are particularly keen t prfit maximise, because they culd lse their sharehlders if they d nt receive a high dividend. They are mre likely t have shrt run prfit maximisatin as an bjective, because they need t keep their sharehlders happy. Revenue maximisatin Revenue maximisatin ccurs when MR = 0. In ther wrds, each extra unit sld generates n extra revenue.

6 At the pint Q P1, the firm is perating at MR=0, where revenue maximises. The curve shws hw the pint f maximum ttal revenue is MR =0. Sales maximisatin This is when the firm aims t sell as much f their gds and services as pssible withut making a lss. Nt-fr-prfit rganisatins might wrk at this utput and price. On a diagram this is where average csts (AC) = average revenue (AR). An example f sales maximising is Amazn s Kindle launch. They sld as many Kindles as pssible t gain market share, s they can earn mre prfits in the lng run. It helps keep ut and deter cmpetitrs. The diagram belw summarises each bjective. Behaviural theries e.g. satisficing

7 Anther bjective a firm might have is satisficing. A firm is prfit satisficing when it is earning just enugh prfits t keep its sharehlders happy. Sharehlders want prfits since they earn dividends frm them. Managers might nt aim fr high prfits, because their persnal reward frm them is small cmpared t sharehlders. Therefre, managers might chse t earn enugh prfits t keep sharehlders happy, whist still meeting their ther bjectives. This ccurs where there is a divrce f wnership and cntrl.