Post on 06-Apr-2018
8/3/2019 Essay Question T4W2
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Syllabus requirements
1. Objectives profit maximisation (MC=MR) and
ALTERNATIVES2. COSTS short/long fixed/variable EOS3. Range of competition ± market structures
± Compare Efficiency Equity Innovation Consumer choice
4. Barriers to entry
5. Behaviour of firms ± Price discrimination ± Price and non-price competition ± Collusion and competition ± Interdependence (oligopoly)
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Essay QuestionLarge firms enjoy lower costs thus
they can charge lower prices.
a) Explain why large firms mayenjoy lower costs. [12]
b) Discuss the view that large
firms are beneficial in view of the cost-savings they enjoy [13]
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a) Definition - context
³I am going to offer some definitions and then use the
idea of economies of scale to explain why some firms
can enjoy lower costs´
Introduction ± firm ± unit of production. INPUT ± PROCESS - OUTPUT
Production important to understand supply.
Supply important because its part of the market. Market is important because it is theMECHANISM for allocating scarce resources.
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SUBSTANCE OF ANSWER
b) Explain why large firms may enjoy lower costs.
COSTS ± PAYMENTS TO FACTORS OF
PRODUCTION
Firms consider costs in the SHORT and LONGrun and FIXED and VARIABLE COSTS
Define
Short Run ± rising MARGINAL COSTS.
Long run ± ECONOMIES OF SCALE
Relate to specific industries e.g.
± Airlines ± high fixed costs (planes) ± Mobile phones ± MASS PRODUCTION/standardisedproduct
± Oil refining ± INDIVISIBLE PRODUCTION
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Economies of (large) Scale
The advantages of large scale productionthat result in lower unit (average) costs(cost per unit)
Economies of scale ± the DECISION of the firm about SIZE.
Advantage in some markets
Singtel ± establishing cell phoneinfrastructure expensive (fixed costs) ± MCof additional user at or near zero (variablecosts)
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Understanding Long Run Cost Curves
Successful firms GROW
ONLY if the market can be extended Growth by product ± new factories/offices/shops We can say firms DECIDE on different or larger
sets of factors of production.
P rofit maximising firms will choose the lowest cost set.
This increase in SIZE is known in economics as aSCALE change.
It is useful to TRACK the possible changes inSCALE; this is the LONG RUN AVERAGE COSTCURVE
In the long run ALL costs are VARIABLE
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$
Q [units]0
The entrepreneur in the long run can choose the scale.The COST of SETS OF FACTORS TO PRODUCE
OUTPUT Q ± which would you choose?
Q
A
B
C
The LONG RUN is aboutSIZE and about howbest to combine thedifferent factors.
Should the firm be;
LABOUR INTENSIVE
or
CAPITAL INTENSIVE
or
LAND INTENSIVE
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Sets of FactorsScale 1
Scale 2
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One of these scales willbe the MINIMUM
EFFICIENT SCALE
Scale 3
Scale 4
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LRAC
$
Q [units]0
The entrepreneur in the long run can choose the scale.
However once the choice is made the firm will
move along the SRAC.
The DECISION MAKING period of time.
1.Potential demand2.Capital costs
3.Confidence inter alia
There are an INFINITE number of possible scales.
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LRAC
$
Q [units]0
The entrepreneur in the long run can choose the scale.As the firm GROWS scale changes
The LRAC shows ALL possible decisions.
If the firm is a profit maximiser it willDECIDE to employ the lowest cost set of factors of production.
12 3
4
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$
Q [units]0
The entrepreneur in the long run can choose the scale.Minimum Efficient Scale ± one combination of factors
will be at the lowest point of the long-run cost curve.
MES
1
2 3 4 5
6
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LRAC
$
Q [units]0
The entrepreneur in the long run can choose the scale.The OPERATING period of time.
ATC
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LRACH
$
Q [units]0
The entrepreneur in the long run can choose the scale.FIRMS/INDUSTRIES ARE DIFFERENT.
LRACOR
LRACPUB
The most productively efficient output depends on the
industry we talking about.
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Internal Economies of Scale
Advantages that result from the growth of the firm
Internal economies take place inside thefirm
± Technical
± Commercial
± Financial
± Managerial
± Risk Bearing
Collateral ± value of assets Banks
Bulk buying Supermarkets
Cubic Capacity Area x 2 Volume x 8; OIL TANKERS
Sales in different countries; Apple
Division of labour; Singtel ± accountants, marketing, HR
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External Economies of Scale
The reduction of costs if the INDUSTRYgrows.
Support services ± The Port in Singapore
Transport
Insurance
Finance Training ± university courses
FIRMS may benefit ± question focus
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Firms that continue to grow MAY
experience rising costs Diseconomies of scale ± Rising costs of management and control
± Employment of staff who supervise, measure
and monitor ± but do not contribute directly tooutput
If the large firm makes SUPERNORMALPROFIT there is a risk of X-inefficiency.
The economies of scale can be shown ona model.
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A Typical Long-Run Average Total Cost Curve
Q
Costs perunit ($)
10
50
55
20
60
15 40
LRAC
13-18
0
Economies
of Scale
ConstantReturns
to Scale
Diseconomies
of Scale
Minimum Efficient Scale ± the lowest
point of the LRAC
Decreasing
returns to scale
Increasing
returns toscale
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Conclusion³The reasons I have given above explain how
large firms can may enjoy lower costs.´ BUT
Industries are different Different consumers (MARKET SIZE)
± Standardised product ± big firms ± Non-standardised product ± smaller firms
Large firms can also charge lower prices tosome customers because they canDISCRIMINATE. (based on price elasticity of demand)
Lower prices may also be due to LIMIT or PREDATORY pricing ± where large firms use their MARKET POWER to reduce competition.
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Discuss the view that large firms are beneficial inview of the cost-savings they enjoy [13]
As shown in part A economies of scaleCAN reduce LRAC.
A number of issues can be discussed ± Benefits to who? VALUE JUDGEMENT/ NORMATIVE
Competition and market share
EOS as a barrier to market entry
± Not ALL industries can become µlarge¶. Large market
Standardised product ± CONSUMER CHOICE
DISCUSS
Thesis Antithesis
For Against
Strengths Weaknesses
Advantages Disadvantages
Positive Negative
Look for the discussion territory ± before writi ng your answer ± make some notes.
Look out for VALUE JUDGEMENTS
/NORMATIVE ECONOMICS
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Benefits
Producer
± Price higher output lower than in a competitivesituation.
± SNP ± (possible wider benefits) Society
± If the most efficient size involves big firms this maysave scarce resources (prevent wasteful duplication)
± The Public Utilities Board (PUB) for example and theprovision of piped water is a NATURAL MONOPOLYthat may prevent wasteful duplication.
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Stakeholders
Consumers
Producers
Government
Workers Managers
Suppliers
S
ociety Alternative (real world) objective ±stakeholder satisficing)
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Consumer Benefits
If cost savings are passed on to theconsumer.
Large firms can SHARE high fixed costsover many outputs.
e.g. Exxon-Mobil oil refining ± litre of fuelless than $2
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Exxon-Mobil ± Singapore¶s largest manufacturing
capital investment ± costs $5-6 billion
How can Exxon-Mobil sell a litre of petrol for $2 (c)?
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Economies of Scale: Effect on average fixedcosts for Exxon-Mobil ± a potential BENEFIT
to consumersy
x0
Average andTotal Fixed
Costs
(S$)
Quantity (units)
Total Fixed Costs
Average
Fixed
Costs
(AFC)
AFC = FC/Q
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Workers
Jobs ± employment
Large firms may less FLEXIBLE to
changes in consumer demand (IBM?) Unclear whether large firms BENEFIT
workers.
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The case against
Consumers buy goods and services for a varietyof reasons ± COST (PRICE) are not the onlyinfluences on demand.
Although price may influence our choice of food
it is NOT the main reason we buy. Some markets by definition are small
There is little scope for economies of scale.
The manufacture of jewellery for example iswhere many people want a more personalisedproduct (and service).
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The importance of CONSUMER CHOICE
Large firms may dominate markets andreduce consumer choice.
Buying a NEW car in Singapore for example there are only a small number of dealers ± some of whom have aMONOPOLY.
There is the potential for consumer exploitation and INEQUITY.
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Benefits?
Competition ± allocative efficiency/ productiveefficiency as shown in perfect competition.
Markets may be dominated by a small number of largefirms. ± Restricting consumer choice
Large firms may use PERSUASIVE advertising toencourage sales. ± Some people argue that some advertising is a waste of resources
± Advertising can distort CHOICE.
Large firms may use their MARKET POWER to eliminate
smaller more efficient producers ± predatory pricing. ± Microsoft ± gave away IE ± killed other browsers
Large firms may use economies of scale as barrier tomarket entry.
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The Inefficiency and Inequity of Monopoly
Quantity0
DemandMarginal
revenue
Marginal cost
Monopolyprice
Deadweightloss
Efficientquantity
Monopolyquantity
Price
The MC curveCAN be seen asthe INDUSTRY
SUPPLY curve inperfect
competition.
Price in
competitivemarket
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It¶s the market model
Quantity0
Demand
Supply
Monopolyprice
Deadweightloss
Efficientquantity
Monopolyquantity
Price
Price
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Examples where large scale isµbeneficial¶
Large firms MAY earn SNP and have theCAPACITY to INNOVATE
This is most likely in the oligopolistic
market structure where non-pricecompetition is important.
Cars
Pharmaceuticals ± Also use of SNP ± innovation/product
development BENEFITS SOCIETY
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Where is the competitive SUPPLY curve likely to be?
Quantity0
DemandMarginal
revenue
MCm
Monopolyprice
Monopolyquantity
Price($)
Would the sum of MCs be HERE inperfect
competition?
Price in
competitivemarket
MC= S
in PC
Efficientquantity
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In some industries lower costs (standardisedproducts) are not a consumer benefit.
Clothing (?) ± limited scope
Hairdressing
Airlines ± safety Surgery (?)
Can cost cutting lead to lower quality?
Large firms X-inefficiency (Leibenstein)
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Conclusion
The idea of µbenefits¶ is complex. There is evidence in some industries - chemicals, oilrefining that economies of scale reduce costs ANDbenefit consumers.
Where a non-standardised product is preferred there are
fewer benefits from the economies of scale. Producers are aware of these issues. The Apple I-phone is standardised (2 colours) However many people buy cases to protect and
personalise their phone.
In some industries consumers may receive greater benefits through competition. The hawker centres are unable to benefit from
economies of scale and competition between vendorsmay help to keep prices lower.
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Review
There is no single way to write essays Plan (MAKE NOTES ± you can leave them for
the examiner to read if you wish)
State answer strategy
Read question from time to time
Stick to the question focus
Hit the µHOT BUTTONS¶ in the syllabus
Be thoughtful Relate your answer to the real world whenever
you can.
QUESTIONS
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Output (Q)
C o s t s ( $ )
AFC
AVC
MC
x
AC
z
y
Average and marginal costs in the S/R Average and marginal costs in the S/R