Business Economics and the Distribution of Income

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  • Created on: 11-05-13 17:24
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The Objectives of Firms
In Economics, it is assumed that the main objective of firms is to maximise its profits. It does this when
Marginal Revenue equals Marginal Costs (MR=MC). Profit plays key roles in economics such as
rewarding entrepreneurs, allocating resources and incentives to eliminate waste and to invest as
well as being an important source of financing investments
However, Profit Maximisation is only one of five objectives for a firm. The other objectives are:
· Revenue Maximisation
· Increasing and Protecting market share
· Surviving recession/slow recovery
· Pursue ethical business objectives
Within a firm there are various groups such as shareholders, managers and employees whom all have
different objectives for their specific needs so to say that an objective of a firm is solely profit
maximisation would be untrue.
As an example a firm may decide to increase their market share in an industry and grow in size which
allows them to attain economies of scale or to gain some form of monopoly power. They would do
this by maximising their revenue when MR=0.

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Divorce of Ownership and Control
Divorce of ownership and control is where the people that own the business (the shareholders) are
not the same as the people that control the business (the board of directors).
Where there is a divorce of ownership and control it affect the conduct of the firm (which objectives
it pursues) and its performance in terms of economic efficiency and equity.…read more

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In the long run, all factors of production are variable. How the output of a business responds to a
change in factor inputs is called returns to scale.…read more

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Fixed costs are the overhead costs of a business. They are important in markets where the fixed
costs are high but the variable costs associated with making a small increase in output are relatively
Total fixed costs (TFC) remain constant as output increases
Average fixed cost (AFC) = total fixed costs divided by output
Average fixed costs must fall continuously as output increases because total fixed costs are
being spread over a higher level of production.…read more

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A change in variable costs
A rise in the variable costs of production leads to an upward shift both in marginal and average total
cost. The firm is not able to supply as much output at the same price. The effect is that of an inward
shift in the supply curve of a business in a competitive market.
An increase in fixed costs has no effect at all on variable costs of production. This means that only the
average total cost curve shifts.…read more

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In the long run all costs are variable and the scale of production can change (no fixed inputs)
-Economies of scale are the cost advantages from expanding the scale of production in the long
run. The effect is to reduce average costs over a range of output.
-These lower costs represent an improvement in productive efficiency and can give a business a
competitive advantage in a market.…read more

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Expensive (indivisible) capital inputs: Large-scale businesses can afford to invest in specialist
capital machinery.
-Specialization of the workforce: Larger firms can split the production processes into separate
tasks to boost productivity.…read more

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External economies of scale occur outside of a firm but within an industry.
Example include investment in a better transportation network servicing an industry will
resulting in a decrease in costs for a company working within that industry and the
development of research and development facilities in local universities that several
businesses in an area can benefit from.…read more

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Technological Change
Innovation is "making changes to something established"
Invention is the act of "coming upon or finding: discovery"
Product innovation is often associated with small, subtle changes to the characteristics and
performance of a product.
New markets and "synergy demand":
Product innovation creates new markets, especially when new technology creates radically
different products for consumers.
Innovation is also a source of synergy demand.…read more

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Cost reducing innovations cause an outward shift in market supply and provide the scope for
businesses to enjoy higher profit margins with a given level of demand. Process innovation should
also lead to a more efficient use of resources.
The diagram above uses cost and revenue curves to show the effect of driving down production
costs from SRAC1 to SRAC2 ­ leading to lower prices and a higher output.
Supply-side strategies are usually linked directly with attempts to promote more innovative
behaviour.…read more




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