Business Economics

	BUSINESS ECONOMICS Edexcel A Level Unit 3 Conglomerate merger				A merger between two firms producing unrelated products.
	Demerger		When a firm splits into two or more independent businesses.

	Horizontal merger/integration		A merger between two firms in the same industry at the same stage of production.
	Merger, amalgamation, integration or takeover.				The joining together of two or more firms under common ownership.

	Vertical merger or integration				A merger between two firms at different production stages in the same industry.
	Why do firms grow?		To increase market share, benefit from greater profits, increase sales, increase economies of scale or gain power.

	How can firms grow?		Either horizontally or vertically (through either forward, backward or conglomerate).
	Name eight ways why some firms remain small?				Legal barriers (need permits maybe), Overt barriers (imposed by other established businesses) Sunk costs (unrecoverable costs on market exit) Because they are in a Niche-market Lack of expertise Optimum efficiency has been achieved Benefits of staying small (financial support) Lack of motivation (owner wants to live a leisured life, less stress) Avoid attention from potential buyers

	Why do some firms break up?				Some firms grow too large and experience diseconomies of scale, because of this increase in average costs firms can choose to demerge (breakup). This leaves a smaller number of firms who can maximise economies of scale and concentrate on their specialist area.
	What are total fixed costs?		Costs that do not vary with output and can only apply when one factor of production (land, labour, capital and entrepreneurship) is fixed. This can only occur in the long run.

	What are variable costs			Costs that vary with output which can occur both in the short and long run.
	Where does productive efficiency occur?				At the bottom of the average cost curve. It is the lowest unit costs where the firm is producing as much as possible using the fewest amount of inputs.

	Where does allocative efficiency occur?		When a firm produces a mix of goods using scarce resources in a way that meets the demands of consumers.
	How much will firms charge for the goods if they are performing at allocative efficiency?				The prices equal to the marginal costs of manufacturing the good.

	What is the formula for average fixed cost?				Fixed costs / Output
	What is the formula for average variable costs?		Variable costs / Output

	What is the formula for marginal cost?				Change in total cost / Change in output
	Where does the marginal cost curve always go through?		The minimum point of the average variable cost and average total cost curves.

	What are economies of scale?		The benefits brought to a business from an increase in size.
	Name the 5 main internal economies of scale.				- Financial economies (banks more willing to lend) - Risk-bearing economies (wider customer base and products) - Marketing economies (as firm increases product range, can advertise brand in every advert) - Managerial (can afford to increase productivity through specialists) - Increased dimensions (double size = double costs = 8x volume)

	How may external economies of scale help a business?		A firm may be able to benefit from innovations provided by other firms or may be able to share administrative facilities with other businesses. This would reduce LRAC for all concerned businesses.
	What are disconomies of scale?				Adverse effects brought to a business by increases in size.

	What diseconomies of scale can occur and how may they have come around?		Managerial or communication problems. These may have happened due to internal growth or through mergers, where management lacks the resources or experience necessary to maintain managerial focus or control.
	What is and how do you calculate total revenue?				The turnover of a firm. Price X Quantity = TR

	What is and how do you calculate average revenue (AR)?				The revenue a firm receives per unit of output. Total revenue / Quantity
	How do you work out marginal revenue?		You find the change in total revenue of selling one more unit of output. It is the price of a product.

	Why is AR and MR downward sloping?				To reflect the downward-sloping demand curve and the need for firms to lower prices to increase sales.
	Where does profit maximisation occur?		At the output level where super-normal profits are at their greatest (or where losses are at their lowest). Marginal cost must also be rising and equal to marginal revenue.

	What will a firm aiming to revenue maximise do?		Make as much revenue as possible. This means selling goods until the last unit sold adds nothing to the revenue as it will know the next unit sold will reduce revenue.
	What are the two main pricing strategies designed to gain market share?				- Predatory pricing (pricing low enough to drive firms out by reducing profitability) - Limit pricing (pricing low enough to limit profits, which discourages new market entrants)

	Does predatory and limit pricing benefit the consumer?		In the short term, yes, as prices as lower. In the long run however the loss of constestability will mean the firm can raise prices and reduce consumer surplus.
	What can non-price competition include?				- Advertising - Branding - After care/ customer service /warranties - Product development and innovation - Product placement (where the product is sold, nicer retail outlet?)

	What can conflict with the rational profit maximisation motives of a firm?		Managers and owners. They may decide to maximise their own welfare or personal ego, perhaps by trying to overtake rivals or taking significant risks.
	How may managers let themselves off the hook whilst not doing what is best for the business?		They can profit satisfice; that is not to see profit as a goal but a goal that must be fulfilled at a minimum level in order for other objectives to be followed (e.g. improving one's golf game).

	What is the concentration ratio?				The market share controlled by the 'n' largest firms.
	What are the characteristics of perfect competition?		Many, small firms selling homogenous products. Each firm has perfect knowledge (or at least access to rival firms' price and output decisions). There are no barriers to entry or exit and each firm is a price taker (takes the price set by the market).

	Why can't firms in a perfectly competitive market achieve supernormal profits in the long run?				Because rival firms will see that supernormal profits are being made (perfect knowledge) and enter the industry (no barriers to entry). This is known as long run equilibrium.
	What are the main characteristics of monopolistic competition?		There are many small firms all selling slightly differentiated goods, with imperfect knowledge (though know when supernormal profits are being made), with low barriers to entry/exit and some price setting power.

	Why can't a firm a monopolistically competitive firm maintain supernormal profits in the long run?				Due to the low barriers of entry and exit, new firms after detecting supernormal profits can enter the market.
	What are the main characteristics of an oligopolistic firm?		It is one of few large firms in a market selling similar but branded goods. They have imperfect knowledge, high barriers to exit/entry (sunk costs) and large price setting capabilities.

	On what do oligopolistic firms tend to compete on?		Anything non-price related do to the unnecessary revenue lost of entering into a price war. Therefore they make use advertising, branding, product quality, innovation, packaging, free gifts or loyalty cards to persuade customers to buy their goods.
	What factors promote collusion within oligopolistic firms?				The similarity of the costs, the few number of firms, high barriers to entry (keeps number of firms small and protects existing firms from new entrants if supernormal profits are being made) and low levels of regulation.

	Why might firms fail to collude succesfully?		They may get landed with a significant fine or a lack of trust may lead to a firm being incentivised to lower their prices below what is agreed.
	What are the characteristics of a monopoly?				One firm selling a unique product, with imperfect knowledge (opaque pricing and output strategies) with large price setting capabilities.

	What is the most allocatively efficient point for a firm to operate on?				P = MC
	Why do monopolies act with neither productive or allocative efficiency?		Because there is no or very little competition, there is no motivation to do so as profits can simply be increased with price.

	What do monopolists seek to do?		Maximise profits by operating on the elastic part of the demand curve and so diminish consumer surplus (the price above what customers were willing to pay above what they do pay).
	Name 4 potential disadvantages of monopoly power.				- High barriers to entry and supernormal profits means the monopolistic firm can afford to be lazy and unwilling to innovate, especially as they do not produce at the most productively efficient point of output. - Can mean high prices and lower output for domestic consumers. - Resources may be wasted by cross-subsidisation (firms financing losses with profits from other sectors). - Setting prices above marginal cost may lead to a misallocation of resources.

	Name 4 potential advantages of monopoly power?				- Supernormal profits mean there is enough capital to innovate and work on efficiency - Employment can be more stable due to large capital reserves - Firms have financial power to match large overseas competitors and so can work positively on BOP. - Cross subsidisation can mean a greater range of goods or services availible to the consumer that give external benefit (provision of rural, unprofitable bus routes?).
	What is price discrimination?		When a firm sells the same product to two different markets with differing elasticities at different prices.

	What does price discrimination allow firms to do?		Increase profits and reduce consumer surplus (that is the amount above what they pay than they were willing to pay).
	What three conditions must a firm fulfill to embark on price discrimination?				- Have high barriers to entry and a degree of monopoly power - Identify at least two separate markets with differing elasticities - Keep these markets separate at a cost that is lower than the gain in profits (to prevent resale between markets).

	What is first-degree price discrimination?		A primarily theoretical method of price discrimination whereby the seller must know the absolute maximum price that every consumer is willing to pay, effectively eroding all consumer surplus.
	What is the best real life example of first-degree price discrimination?				Auctions/Ebay, as consumers can bid for as high as they are willing to pay.

	What is second-degree price discrimination?		A type of price discrimination based on the amount or volume sold, for example bulk buying.
	What is third-degree price discrimination?				Price discrimination based on regional, age or time differences.

	What is an example of third-degree price discrimination?				Charging different prices for adult and child train tickets or charging differently for peak and off peak gas, electricity or phone services.
	What is a natural monopoly?		Where an industry can only support one firm and so typically has very high sunk costs and requires large levels of output to exploit economies of scale.

	What is an example of where natural monopolies occur?				In the supply of water, gas and electricity; there are high start up and infrastructure costs which would outweigh any economic or social benefit derived from setting up the competing firm.
	What is a contestable market?		Where a market has low sunk costs and so low barriers to entry and exit. New firms can easily enter the market when they see supernormal profits can made.

	What is a monopsony?		A market in where there are many sellers but there is only one buyer.
	Give some examples of monopsony.				The NHS, the MoD or large supermarkets such as M&S (not a pure monopsony).

	When does the Competition Commission conduct inquiries into mergers?				If a merger will result in a market share greater than 25% or a combined turnover of £70m or more.
	What is the Competition Commission's job?		To stop anti-competitive practices and so anything that 'prevents, restricts or distorts competition'.

	Why were regulators put in place in the UK?				Because of the privatisation of state-owned monopolies, electricity and water firms were appointed a regulator instead of competition to set prices and maintain quality.
	What does RPI - X do?		RPI - X takes the retail price index and subtracts the factor 'x' determined by the regulator. 'X' represents the efficiency gains that the regulator has determined can reasonably be achieved by the firm in question.

	What does RPI + K do?		RPI + K uses RPI but allows the addition of the 'K' factor, which accounts for any necessary capital spending that a firm has agreed with the regulator is necessary.
	What are the benefits of RPI + K?				It allows the firm to profit from any efficiency gains that it makes, motivating it towards being productively efficient. In addition, as 'X' and 'K' are fixed for 5 years they can plan ahead and not be penalised for any further (maybe unsustainable) efficiency gains.

	How does the method of rate of return work?		This primitive regulatory method, used in the USA before price capping was devised allows a firm to make a certain level of profit based on their capital, whilst the rest is taxed at 100%.
	What is the problem with the rate of the return method?				Firms are not rewarded for efficiency gains and instead penalised for extra profit. They are also encouraged to over state their capital in order to increase the rate of return of investment and increase profits.

What are performance targets?

Where a regulator sets performance targets which are monitored and can lead to fines if not fulfilled. These can be anything from improvements in the quality of service or reductions in customer complaints.