The firm: Objectives, Costs and Revenues

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  • The Firm: Objectives, Costs and Revenues
    • The Objectives of Firms
      • Profit Maximisation
        • A rule  to Decide Whether to Producce
          • A firm should not produce if producing that unit does not cover variable costs
          • In the short run a firm should produce only if total revenue is > or = to total variable costs.
        • A Rule to decide How much to produce
          • A firm stops producing when MC=MR as this is the point of profit maximisation
          • When MR>MC profits rise when output increases When MC>MR profits rise when output reduces
        • Normal Profit is the minimum profit a firm must make to stay in business.
        • Supernormal profit is profit over and above normal profit
      • Profit Satisficing
        • This is achieving a satisfactory objective acceptable to all the competing member groups of the coallition that makes up the firm. I t mainly in monopolies and imperfectly competitive firms due to barrriers to entry.
      • Long Term Survival
      • Share Price Maximisation
        • Firms believe that maximising share prices increases monopoly power enabling them to boost prices and achieve greater long run profit
        • Managers want to work for bigger firms as it leads to greater prestige and salaries.
        • Higher share prices can force out competitors
      • Revenue Maximisation
        • This occurs when MR=0 and at the point where PED=1
      • Brand Loyalty
        • Some firms aim to build relationships with brands in the short run so they can get lower prices in the future and therefore make profits in the long run
      • Expansion and Market Dominance
      • Welfare Maximisation
        • This increases consumer satisfaction and therefore increases returning customers
    • The Divorce of Ownership and Control
      • This is the possibility that directors and managers will persue an agenda of their own, ignoring the share holders interests.
    • The law of Diminishing returns to scale
      • Increasing returns
        • As more units of a variable factor are added to a fixed amount of capital total output will first rise. Each additional worker will be more productive than the last.
      • Diminishing returns
        • When the marginal product begins to fall total product is still rising at a slower rate when more workers are employed. The fixed factor of production will become more scarce decreasing the productivity of worker.
      • Negative Returns
        • Adding more and more of the variable factor will cause total output to fall and so marginal product will become negative. Total product is maximised when marginal product = 0. So adding extra labour adds nothing to total output (too many cooks)
      • The law: If one variable factor of production is increased while other factors stay fixed, eventually the marginal returns from one variable factor will begin to decrease.
      • Production Theory
        • The Short Run is the time in which at least one of the factors of production is fixed and can't be changed.
        • The Long run is the scale of all the factors of production can be changed.
      • Product Curves
        • Marginal Product
          • The addition to total output through adding one more worker to the labour force
          • The highest point on a marginal product curve is where the law of diminishing returns sets in.
    • Types of Cost
      • Costs of a firm
        • A firm is any sort of business organisation
        • An Industry is all the firms providing similar goods.
        • A market is all the firms supplying a good and all the people buying it
        • Revenue is generated through selling output
        • Profit=total revenue-total costs
      • Fixed Costs
        • Average Fixed Costs
          • These are downward sloping curves as total fixed costs are spread over a larger number of units.
        • Total Fixed Costs
          • This is a straight horizontal line as fixed costs do not change e.g rent
      • Variable Costs
        • Total Variable Costs
          • Variable costs vary with output e.g raw materials. The total variable cost line starts at the origin and is a straight diagonal line as costs vary directly with output.
        • Average Variable Costs
          • The average variable cost curve falls as output rises due to workers being more efficient and productive (Specialisation) once the law of diminishing returns kicks in average variable costs begin to rise as output rises.
          • It is a smiley face on the diagram  AVC=TVC/Output
      • Marginal Costs
        • As more and more workers are added marginal labour productivity rises
        • The TVC of production rises at a slower rate than output causing the marginal cost of producing one more unit to fall
        • Once the law of diminishing returns kicks in cost rises with output
      • Total Costs
        • TC=FC+VC
        • The ATC curve falls at a slower rate than AVC as continually falling GC's exert downward pressure on the ATC. This creates a smiley face.
        • ATC's per unit of output fall then rise later as output is increased
      • Average and Marginal Costs
        • If the marginal cost is below the average then it will bring the average down and therefore the average cost will be falling.
        • If the marginal cost is above the average then it will pull the average up
        • The marginal cost curve will cut the average cost curve at its lowest point
    • Economies and Diseconomies of scale
      • Diseconomies of scale
        • Internal diseconomies of scale
          • This means higher long run average production costs resulting from an increase in the size or scale of the firm in the long run
        • External Diseconoies of scale
          • This means higher long run average costs resulting from the growth of the industry of which the firm is a part.
        • Examples
          • Coordination
            • When there's loads of departments to organise
          • Control
            • Controlling all the different departments
          • Communication
            • It's harder to communicate in a big firm
          • Morale
            • People get demotivated if they feel like just another number
          • Price of Input
            • When you use up raw materials it becomes scarce so costs more
      • Economies of Scale
        • Internal Economies of Scale
          • This means lower long run average production costs resulting from an increase in the size or scale of the firm in the long run
          • Plant level economies of scale are economies of scale that occur at a single plant like a factory.
          • Technical economies of scale are when large scale businesses can afford to invest in expensive specialist capital equiptment that smaller competitors couldn't afford
            • Indivisibilities -  when a plant or machinery is indivisible there is a minimum size in which it can't efficiently operate
            • The spreading of research and costs - in large plants costs of R+D can be spread over a larger production run, reducing costs in the long run
            • Volume economies/ Economies of increased dimensions- often costs of capital equipment increase less rapidly than capacity. These economies are very important in industries like transport storage and warehousing.
            • Economies of massed resources - The operation of a large number of Identical machines means a fewer number of spare parts needs to be saved.
            • Specialisation of labour- E.g a production line each employer specialises in one bit.
            • Economies of the vertically linked process- having a larger plant means times costs and energy can be saved in the movement of raw materials
        • External economies of Scale
          • Occur when unit production costs fall because of the growth of the scale of the whole industry or market rather than the growth of the firm itself.
          • Economies of concentration - when a number of firms in the same industry are located close together they gain advantages through pooled labour and transport facilities.
          • Economies of information- In large industries it's beneficial to undertake research that would be available to other firms
          • Economies of disintegration - means that various diseconomies of scale have broken a production process into separate companies.
        • Managerial economies of scale
          • This can be achieved through increasing the size of a plant and or by grouping a large number of establishments under one manager.
          • This allows increased specialisation and the division of labour
          • Multiplant economies of scale occur when long run average costs fall as a result of operation more than one plant.
          • Improved coordination and communication
        • Firm level economies of scale
          • Firms will try to take advantage of any scale economies associated with growth. Economies at eh firm level occur from the firm being large.
          • They cover some of the research and development economies, massed resource economies and managerial economies.
          • Marketing economies- you can either have bulk buying or bulk marketing economies. It is the lower unit cost of promotion that is enjoyed by a large firm that isn't available to smaller firms.
          • Financial/capital raising- These relate to the bulk borrowing of funds required to finance the business expansion. Large firms can borrow from banks at a lower rate than smaller firms There are also more sources of credit available.
          • Risk bearing economies- Large companies are less exposed to risks than small firms.
      • The minimum efficient scale
        • This is the lowest point on the long run ATC curve when economies of scale have been exhausted.
        • It is unlikely to be a single level of output rather than a range of outputs where costs are minimised.
        • The Higher the level of output where the MES kicks in the less room there is for efficient competition it therefore can act as a barrier to entry.
    • Technological Change
      • This is used to describe the overall process of Invention, Innovation, Diffusion of technology or progress. It can cause an outward shift in the PPF or LRAS curve
      • Invention
        • Coming up with completely new ideas that can be patented
      • Innovation
        • Putting an invention to commercial use it converts knowledge to better ways of doing business. It means the firm is dynamically efficient.
      • How it effects a market
        • It can reduce barriers to entry in a market. E.g the internet
        • It can cause more scope for competition in the industry such as a movement away from a monopoly creating more oligopolys
        • It can lead to increased consumer Choice
        • Imperfect competition will exist as it increases the price of set up costs.
    • Total, Average and Marginal Revenue
      • Total Revenue = Output Sold x Selling Price
      • Average Revenue = Total Revenue/ Output Sold
      • Marginal Revenue = Change in Total Revenue/ Change in output

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