revision for unit 3 complete NOW

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Edexcel Economics A2 Unit 3
Business Economics and economic efficiency
Firms
How do firms grow?
Expanding scale of operation & increasing market share
Internal/external
Horizontal: merger between 2 firms in the same stage of production
Vertical: merger between firms at different stages of the production
process (forward/backwards)
Conglomerate: merger between firms in entirely unrelated industries=
diversification, increase in range of goods/services & power in other
markets
Why do firms grow?
Increase in market share= more profits & are better price makers
Greater profits=expansion enables increased sales, setting price & lower
costs of production
Economies of scale= exploit increased size to lower LRAC = more
productively efficient
Power= prevent competition
Satisfy managerial ambitions: seek to run a successful firm, leave a legacy
etc.
Make the most of an opportunity: avoid tax by using profits to acquire
another firm
Gain expertise: develop firms rather than trying to establish themselves
slowly= easier to become a market leader with expertise
Why do some firms remain small?
Barriers to entry
Legal barriers:
gov may prevent entry/growth of firms
nationalised industries can become monopolies e.g. post office/ TFL,
patents to make sure that firms develop products e.g. pharmacy products
licences to make sure that only the best firm offer services e.g. law &
accounts
Marketing barriers

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Page 2

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Pricing barriers
Predatory: p is below costs to drive out other firms that cannot afford to
make such losses
Limit pricing: p at a low enough level to discourage entry of new firms
Technical barriers
Existing firms exploit their technical economies of scale meaning that new
firms can't compete with them because their AC will be so much higher at a
smaller scale
Unless new firms are big= HUGE losses
Niche-market
This type of market will not support expansion due to small scope for
growth…read more

Page 3

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May result in unwanted requests from larger firms to buy
Tax thresholds & other benefits of remaining small
Small= access to grants & financial support, not liable for certain taxes
Why do some firms break up?
Too large=Diseconomies of scale
Growth of output= lose focus & control= LRAC increase
Break up to reduce these BAD impacts = smaller firms able to concentrate
on specialist areas
Costs and revenues
The short run and long run
SR: time period where at least one of CELL is fixed(can't…read more

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Marketing: growth= create a central brand to advertise range at lower
extra cost
Managerial: have a better position to employ specialist= increased
productivity= lower LRAC
Increased dimensions: x2 dimensions= x8 volume
External
When an entire industry expands= lower LRAC
Benefiting from innovations from other firms
Retailers located close to each other benefit from transport links
Small business groups can share administrative & secretarial facilities
Diseconomies of Scale
Grow too large = move beyond minimum efficient scale
Due to managerial & communication issues
Lack of control,…read more

Page 5

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Gov : make sure firms are allocatively efficient where P=MC
Satisficing: making just enough profit to keep stakeholders happy whilst
allowing other motives to be pursued
LR profit maximisation by aiming for market dominance in SR= profits in
LR
Strategies to gain market share/ increase
profitability
Pricing
Predatory: pricing below costs to drive out other firms, make a loss but
increase P once other competitors driven out
Limit: pricing at a level low enough to discourage entry of firms
SR= lower p
LR= monopoly power=…read more

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Knowledge Perfect Imperfect Imperfect imperfect
Barriers to None Low High high
entry/exit
P setting P-taker Some degree Significant but P maker
powers in local interdependent
market
Perfect competition
Many small firms
Homogenous goods
Perfect knowledge
No barriers to entry
Price takers
SR possibility of making supernormal profits
LR always make normal profits only as supernormal profits will have been
competed away due to no barriers to entry
Shut down point is when the firm is not covering avc
Continue in SR as long as it…read more

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P war= unwanted
Characterised by non-p comp
Collusion
Agreement between 2/more firms to limit comp
Illegal due to restrictive nature & - impact on consumers
Overt: openly collude
Tacit: unspoken
Always temptation to break agreement to maximise firm's sales by lowering
P & be a whistle blower thus don't get fined
Kinked D curve: P rigidity & asymmetric reaction to other firms when one
firm raises (P stay the same ) lower prices(all lower)
Raise P= elastic D as consumers will switch= decrease in total…read more

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Contestable markets
Low sunk costs & low barriers to entry/exit
Hit and run profits are possible
Monopsony
When sellers face powerful buyers
Power allows a firm to exploit its suppliers in the knowledge that
the supplier has few options beyond selling to the sole buyer
Low p can be passed onto consumers at the expense of the
supplier of goods
Force supplier to sell stock at lower Ps
Government intervention
Intervene in the working of risk to maintain comp
Competition policy
Introducing regulation
Competition Policy…read more

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Regulation
Direct control by gov of firms
Used when market forces are judged to be inadequate
Protect consumer interests
Gov tries to act as a surrogate for comp by making firms cut P/legal action
Fines if not followed
Controlling the monopolies created by privatisation
Gov appointed as regulator as a surrogate for comp to set P & maintain q in
industries
No need for regulation afterwards
Price capping
Upper limit for the P increase that firms can add to their retail prices
Takes into account…read more

Page 10

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Controls in response to the credit crisis
Banks can only lend in certain amounts to people
Several UK banks were nationalised
Controls from outside the UK
EU rules overrules UK rules…read more

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