Wednesday, 19 May 2010

Economics -- Firms and production II

Expansion of firms
External expansion (integration) -- combining with another firms, additional inputs may be acquired indirectly from another firm. Example: takeover.
Internal expansiongrow on its own; additional inputs must be acquired from the suppliers of theses inputs directly. Examples: new branch or subsidiary.
Horizontal expansion – the expanded business is engaged in the same production stage of the same product of its original products, including substitutes (related+competing products).
Example: Neway Karaoke Box VS California Red
Advantages: economies of scale (specialisation, discounts), increasing market share/power, reduce competition and reduce duplication of facilities.
Vertical expansion – expand to the different production stage of the same product.
Vertical forward – expand to the business of the later stage of the product.
Example: Frozen meet supplier → Beef restaurant
Vertical backward – expand to the business of the preceding stage of the product.
Example: T-shirt manufacturer → Weaving factory
Advantages: economies of scales (specialisation), secures output (forward) or input (backward) of the product, reduce expenses in transactions like negotiation, contracting, monitoring, packaging and marketing; expand brand name to other products. Note that the risk in losing the whole business is increased.
Lateral expansion -- related but not competing products.
Example: MTR VS KCR
Advantages: economies of scale (lower LRAC by attaining synergy), expand brand name, reducing risk by diversification, more efficient use of resources and attract customers by offering various related products.
Conglomerate expansion – expand to a unrelated products. A conglomerate is a large company composed of different unrelated business.
Example: T-shirt manufacturer → restaurant
Advantages: economies of scale (marketing), reducing risk by diversification, expand brand name, more efficient use of resources and able to invest other more profitable industries.
Market and market structure
Market is the arrangement that enables transactions of a good or services take place. We will only focus the product market here. Note that market may not exist as a matter. It is just an imaginary concept.
Competition forms in scarcity to gain more transactions and hence more profit. Therefore it exists in all markets. Competitions can be further divided as price or non-price competition.
Market structure – describes a typical form of market with specific features and competitive behavior.  It can be divided into perfect or imperfect competition, where the imperfect competition can be further divided into monopolistic, oligopoly or monopoly. # of sellers, ease of entry, and similarity of products and availability of market information will be its indicator.
Perfect competition: large # of small and not associated sellers, free entry, homogeneous (totally identical here) products, and perfect information for both sellers and buyers.
Under perfect competition, all sellers are price takers (must take and sell at market price) since 1)if they rise the price they lose all customers (perfect information); 2)all follow to cut the price if one cuts the price, which led to the profit reduced in the whole industry. Also the profit tends to zero under fierce competition, so there’ll be no competition eventually.
Monopolistic competition: many small and not associated sellers, free entry, heterogeneous products and imperfect information for both buyers and sellers.
Under monopolistic competition, sellers are price searchers since buyers have imperfect information such that the demand isn’t perfectly inelastic. Their price can affect the market price and they will find different price to maximize the profits. They will engage in both price and non-price competition.
Oligopoly: few dominant sellers dominating the market (small sellers can still exist) (main feature), restricted or free entry, homogeneous or heterogeneous products (tends to sell differentiated goods in reality, referring to creating a product’s unique characteristic), imperfect information.
Under oligopoly, sellers are price searchers, interdependent – one dominant seller’s action affect others such as triggering price war, so the price tends to be rigid also since price war led to a great drop of the profit. Also price leadership happens when the main sellers change the price and the small sellers have to follow the suit. Lastly since price rigidity exist, non-price competition is common.
Monopoly: only one (dominant) seller, no entry, homogeneous or heterogeneous products and imperfect information.
Under monopoly, they’re price searchers, engaging in both price or non-price competitions to attract more customers to increase the revenue, and competing with the substitutes too.
The source of monopoly power may come from:
  1. Sole ownership of essential resources/techniques required in production – entry is too high or no entry for new sellers
  2. Sole ownership of patents or copyrights – having the exclusive rights to produce.
  3. Government provision – too strategic for others to supply like national defending system.
  4. Natural monopoly – allows no room for another firm to exist (e.g., max. demand fixed)
  5. Sole ownership of franchise
  6. Integration or collusion – forming cartel and behave collectively like a monopolist.
Profit maximization and output determination
The four main objectives of a firm:
  1. Profit (TR-TC) maximization – to satisfy more wants (The major objective)
  2. Market share maximization, market share refers to either dollar/unit sales: dollar/unit sales of the firm divided by the dollar/unit sales of the whole industry. Maximising market share gives more market power and enjoy economies of scale, as to earn more profit. Note that highest market share may not make the most money. For example, discount is made to attract customers.
  3. Corporate social responsibility (CSR) – responsibility of a firm to all of its stakeholders, who are people who affect or were affected by that firm’s decision and behavior. Obeying laws isn’t enough, but they have to meet the desires and ethical standards of the stakeholders, such as reducing environmental damage and treat their employees fairly.
  4. Provide non-profit making good and services to serve the needs of targeted groups.
Methods to determine profit maximizing level:
  1. TR—TC approach: recall definition: Profit = TR-TC; TR = PQ; and TC = the cost producing the total amount of output. Profit is maximized when the difference between TR and TC is the largest.
  2. MR—MC approach: recall definition: MR of the nth unit = TRn – TRn-1 ; MR = market price for each unit (assume the price for every unit is unique); MC of the nth unit = TCn – TCn-1 , Marginal profit = MR-MC and Total profit of n units = Σ Profits of the ith unit. Note that the profit at zero unit isa negative value which is the TFC (total fixed cost). Now when MR=MC it will be the profit maximizing output level. If the point MR=MC don’t exists, then we say the output level is the level that MR-MC is the closest to zero (positive).
Note that if two output level gives the same TR-TC or MR-MC, we choose the larger output level as to maximize market share as well.
Note that from a marginal cost schedule we can find the profit maximizing output level at each market price. As a result a supply schedule can be deduced. We know that the column of price is equal to the column of MCs while the output column is same as the Qs column.

Recently I found that using MS word → Dreamweaver → blogger is much more effective in bolding sentences (as to avioiding bold two times), and I think the doc. version can be uploaded later (since the supply schedule part may have some problem.)

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