Unit 3 economic notes

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Economics unit 3 notes:
Firms - business organisations where decisions are made. They are typically engaged in the
production of goods and services.
Profit ­ the excess of a firm's revenue over its costs. From an economics point of view, cost means
the opportunity cost of the factors of production used.
Economic Cost = money cost + imputed cost (opportunity cost)
Normal Profit ­ the minimum revenue for the firm to stay in business ­ total revenue = total cost.
Abnormal Profit ­ any profit above normal profit.
Accounting Profit = sales revenue ­ accounting Cost (money cost)
Economic Cost = accounting cost (money cost) + Opportunity Cost of the factors of production
(imputed cost) (the wages and interest you would have been earning).
Economics Profit (abnormal profit) = Sales revenue ­ Economics Cost
The Entrepreneur ­ an economic agent who perceives market opportunities and assembles factors
of production to exploit them in a firm. E.g. Richard Branson (Virgin), Lane Fox (Last Minute) etc.
Example of small company breaking through ­ in the £400 million a year UK wet razors and blades
market, Gillette has an estimated 80-85% share. King's company, which sold its first bottle of shaving
gel in 1993, now has 10% of the UK market for wet shaving products and has made a small start in
what was thought to be an impregnable competitive arena for razors dominated by Gillette and
Wilkinson Sword.
The government introduced the StartUp loans programme in 2012 which is targeted at 18-24 year
olds who find difficulties when applying for loans from banks. Typical loans will be about £2,500 with
interest charged at inflation +3%. The loan will have to be repaid in 5 years. It is hoped that the
scheme will launch 30,000 start-ups.
Social entrepreneurship has been more prominent since the start of the 21st Century. The social
entrepreneur runs firms that tackle social or environmental issues while also attempting to make a
profit. An example of one such company is The Body Shop who are against animal testing and try to
be as environmentally friendly as possible.
As well as this, The Big Issue, the Eden Project and Jamie Oliver's Fifteen which helps socially
excluded young people are examples of social enterprises.
Measures of the size of a firm:
1. Sales turnover
2. Numbers employed
3. Market share
4. Stock market value
5. The value of its assets.
Types of firm:
A sole trader is a firm owned by one person who usually makes all the decisions, although there may
be other people employed by the firm.
A partnership is owned between 2 and 20 partners who enter into a partnership agreement. Some
partners play no active role in the running of the business and are called sleeping partners.

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Page 2

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Both types of business have unlimited liability. This means that the owners are liable in full for all
the debts of the business, and the lenders can take personal possessions if the loan repayment is not
meet by the assets of the business.
On the other hand, companies have limited liability, which means that if the business goes bust, they
cannot take the personal possessions of the owner.…read more

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Co-operatives ­ independent businesses may join together to gain the advantages of
bulk-buying while still retaining their independence. A good example is the UK grocery chain
SPAR. There are 2,600 stores and £2.6 billion in retail sales a year.
6. Monopoly power. Large firms may choose to allow smaller firms to exist in order to disguise
restrictive practices.
7. Some firms often remain small because they are unable to raise the finance that would
enable them to expand.
8.…read more

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Economies of scale. Expansion of output in the case of horizontal integration offers potential
for lower long run average costs from a wide range of sources (technical, managerial etc.)
3. Diversification. Conglomerate and lateral integration take firms into different product areas,
making them better able to withstand a slump in any one market, while horizontal integration
can give more geographical or brand diversification.
Integration is not always a success. The potential for diseconomies of scale should be considered.…read more

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However, even if MC is falling total costs will still be rising as long as MC is positive. The basis of costs
in the short run rests on the law of diminishing returns. The shapes of the MC and AVC are based
on increasing returns and diminishing returns. The AC curve will fall when both AFC and AVC are
falling, but it will rise when the fall in AFC is less than the rise in AVC.…read more

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Total Revenue = Price × Quantity.
Average Revenue = Total Revenue
Short run profit Maximisation:
The difference between revenue and cost is supernormal profit.
MR slopes twice as steeply as the AR curve.
The profit maximising level is where MC=MR. you take
the line up to the AR curve to get the price.
Revenue Maximisation:
Is where MR=0 because all MR values up to where MR=0
have been positive and has brought a net increase in total
revenue.…read more

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Managerial theories of the firm:
Managerial theories are based on the assumption that managers control the company. Managers
may have their own agenda, and wish to pursue goals such as maximising their own prestige or even
simply enjoying an easy life. Sometimes perks and status are not tied directly to profit maximisation
and thus managers make enough profit to prevent a shareholder revolt, while still enjoying the perks
afforded by not striving to maximise profits. This is a form of profit satisificing.…read more

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Freedom of entry ensures the only normal profit will be made in the long run, as any short run
supernormal profits will attract new firms into the market and erode profits. As new firms enter, the
industry's supply curve shifts to the right, lowering the market price. If they are making profits, firms
will continue to enter the industry until only normal profits are made, at which point no further
incentive in given for firms to enter the industry.…read more

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Monopolistic competition:
Market characteristics:
1. There are heterogeneous products as there is not perfect knowledge.
2. They are price makers.
3. Their aim is to maximise profits.
4. Lots of small firms.
5. No barriers to entry
Differences in the products can lead to brand loyalty. A customer may be willing to pay a higher
price for the product of one firm than for that of another in the same market. And so, in this case, is a
price maker.…read more

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A few firms dominate the market. They have high levels of market concentration.
Neo-Classical Theory assumes that barriers to entry are a function of the size of the firm.
Small firms don't have them, big firms do.
Some oligopolies produce identical products (e.g. metals) but most produce differentiated products
(e.g. cars). If the product is homogenous, than price competition or price fixing can occur.…read more


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