Unit 3 Economics, Edexcel

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Matthew Mavin-Economics unit 3
A firm is a production unit. It transforms resources into goods and services
"Industry" is used to describe a collection of firms operating in the same production process
How do firms grow?
Firms can grow by expanding the scale of their operations and gaining market share. This is
known as internal or organic growth. They can also grow through takeovers (inorganic
growth) of which there are a number of different types
Horizontal integration: Merger of two firms at the same stage of production
Vertical integration: merge of firms at different stages of the production process within an
industry. Reason for merge; increase barriers to entry, increase control over suppliers or
markets or to ensure a smooth production process. Two types:
- Forward vertical: Goes up the production chain
- Backward vertical: Goes down the production chain
Conglomerate integration: merger between firms in an entirely unrelated industry. Reasons;
spread risk and/or wider range of output to reduce exposure to any one market.
Why do firms grow?
They may decide to grow larger:
- Increase market share
- Benefit from greater profits
- Increase sales
- Increase economies of scale
- Gain power
- Satisfy managerial ambitions
- Gain expertise
Why do some firms remain small?
Barriers to entry
- Barriers to entry or exit of an industry are obstacles that ensure the continued
existence of monopoly power of firms in a market
Legal barriers
- Government may prevent entry or growth
- Acts of parliament can allow monopolies to be formed/protected
- Patents also five firms legal protection
- Some industries require licences or specific qualifications before a firm or individual
can operate
Marketing barriers
- Barriers imposed by businesses currently operating in an industry
- This could be through bonding/advertisement
- Investment in marketing e.g. advertising, cannot be recouped if campaign fails, this
is known as a sunk cost

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Matthew Mavin-Economics unit 3
Technical barriers
- Few large firms may dominate due to sixe
- They use existing expertise and economies of scale to ensure they operate at the
lowest possible average cost and new firms entering the market will find it
impossible to compete.
Niche-market business
If a firm serves a niche market that will not support expansion there is little space for
E.g. Manufacturers of cricket balls have expanded as far as their market will allow.…read more

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Matthew Mavin-Economics unit 3
Why do some firms break up?
Some firms may grow too large and experience diseconomies of scale. As a result of the
growth of output, the business and managers may lost focus and control over day to day
management of the firm and therefore long-run average costs increase
To avoid this firms may decide to break up i.e. demerge.…read more

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Matthew Mavin-Economics unit 3
Marginal costs always foes through the minimum point of the average variable cost and
average total cost curves
If MC > AC then AC must be rising
If AC > MC then AC must be falling
Only time when the AC is not falling or rising is when MC =AC
Costs MC AC
returns to a
fixed factor AFC Diminishing
returns to a
fixed factor
The gap between the AC and the AVC gets smaller as output rises.…read more

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Matthew Mavin-Economics unit 3
Economies and diseconomies of scale
Economies of scale
Internal economies of scale
Internal economies of scale are falling long run average costs associated with an increase in
output for an individual firm
Types of economies of scale include:
Financial economies, banks more willing to lend as there's less risk
Risk bearing economies, as firms expand, it is better to be able to develop a range of
products and a wider customer base to spread risk and minimise impact of any downturn…read more

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Matthew Mavin-Economics unit 3
Total revenue = price x quantity
Average revenue: how much people pay per unit (price) and also the demand curve
AR = Total Revenue/quantity
Marginal revenue
- Mr is the revenue associated with each additional unit sold. I.e. the change in total
revenue from selling one more unit.…read more

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Matthew Mavin-Economics unit 3
Pricing strategies
Predatory pricing
Pricing below costs to drive out other firms. In the short run firms make a loss but as other
firms leave the prices are raised to higher levels than would have been possible with
competition. This is anti-competitive practice and can lead to fines by the competition
Limit pricing
Pricing at a level low enough to discourage entry of new firms.…read more

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Matthew Mavin-Economics unit 3
Perfect competition
Many firms
Homogenous goods (Exactly the same)
Perfect knowledge
No barriers to entry/exit
No price setting powers, price set by market
Short-run supernormal profits in perfect competition
Revenue/ S
Costs MC
Supernormal profits
Q Quantity Quantity
Profit maximising output - MC=MR (supernormal)
Perfectly competitive firms cannot maintain supernormal profits in the long run as rival firms
will see these supernormal profits (due to perfect knowledge) and enter the industry (no
barriers to entry)…read more

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Matthew Mavin-Economics unit 3
Long-run equilibrium in perfect competition:
Q Quantity
Monopolistic competition
Many small firms
Similar goods
Imperfect knowledge about rival firms price and output decisions but firms can identify
when supernormal profits are being made
Low barriers to entry/exit
Can set prices to an extent
Supernormal profits in short run monopolistic competition
Revenue/ MC
Long-run equilibrium in monopolistic competition
Revenue/ MC
Supernormal Costs
Q Quantity
Q…read more

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Matthew Mavin-Economics unit 3
A few large firms
Goods with some similar characteristics but brand loyalty tends to be strong
Imperfect knowledge about rival firms price and output decisions
High barriers to entry/exit
Can price set but may decide to agree price-fixing deals with rivals to avoid price
Only a few firms dominate the industry (high concentration ratio) therefore they tend to
avoid price competition.…read more


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