Download firm - JKU

Prof. Dr. Friedrich Schneider
Institut für Volkswirtschaftslehre
http://www.econ.jku.at/schneider
Recht und Ökonomie
(Law and Economics)
LVA-Nr.: 239.203
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(3) Business Economics
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Content
(1) The growth of firms.
(2) Key issues.
(3) Efficiency.
(4) Motives of firms.
(5) Competition.
Source chapter (1) - (4): http://www.bized.co.uk
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1. The Growth of Firms
1.1. Internal Growth
Growth of firms  internal or external.
1.1. Internal Growth:
 Generated through increasing sales.
 To increase sales firms need to:
 Market effectively.
 Invest in new equipment and capital.
 Invest in labour.
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1. The Growth of Firms
1.2. External Growth
1.2. External Growth:
 Through:
 amalgamation,
 merger, or
 takeover (acquisitions).
 Mergers  agreed amalgamation between two firms.
 Takeover  One firm seeking control over another:
 Could be “friendly” or “hostile”.
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1. The Growth of Firms
1.2. External Growth (cont.)
External growth – three types of acquisition:
(1) Vertical Integration
(2) Horizontal Integration
(3) Conglomerate Merger
1.2.1. Vertical Integration:
 Amalgamation, merger or takeover at different
stages of the productive process.
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1. The Growth of Firms
1.2.1. External: Vertical Integration
Primary
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Vertical Integration
BACKWARDS –
acquisition takes place
towards the source.
Secondary
Manufacturer
Tertiary
Retail Stores
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1. The Growth of Firms
1.2.1. External: Vertical Integration (cont.)
Primary
Secondary
Dairy Farming
Cooperative
Vertical Integration
FORWARDS –
acquisition takes place
towards the market.
Cheese
Processing Plant
Tertiary
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1. The Growth of Firms
1.2.2. External: Horizontal Integration
Horizontal Integration:
 Amalgamation, merger or takeover at the same
stage of the productive process
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1. The Growth of Firms
1.2.2. External: Horizontal Integration (cont.)
Primary
Secondary
Confectionery
Manufacturer
Soft Drinks
Manufacturer
Tertiary
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1. The Growth of Firms
1.2.3. External: Conglomerate Acquisition
Conglomerate Acquisition:
 Amalgamation, merger or takeover of firms in
different lines of business.
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1. The Growth of Firms
1.3. Motives
 Cost Savings
 Shareholder Value
 External growth may be
cheaper than internal growth
- acquiring an
underperforming or young
firm may represent a cost
effective method of growth.
 Asset Stripping
 Selling off valuable parts of
the business.
 Economies of Scale
 Managerial Rewards
 External growth may satisfy
managerial objectives power, influence, status
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 Improve the value of the
overall business for
shareholders.
 The advantages of large
scale production that lead to
lower unit costs.
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1. The Growth of Firms
1.3. Motives (cont.)
 Efficiency
 Control of Markets
 Improve technical,
productive or allocative
efficiency.
 Gain some form of monopoly
power.
 Control supply.
 Secure outlets.
 Synergy
 The whole is more efficient
than the sum of the parts
(2 + 2 = 5!).
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 Risk Bearing
– Diversification to spread
risks.
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2. Key Issues
2.1. Ownership and Control
 Separation between ownership and control – who runs
the business?
 Shareholders?
 Board of Directors?
 Principal-Agent Relationship:
 Shareholders act as principals, Board as agents –
principals expect agents to act in their interest.
 Sub-contracting work operates on a similar basis
(employer = principal; employee = agent)
 Contracts and compensation procedures to ensure
agents act on behalf of principals.
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2. Key Issues
2.2. Diminishing Returns
 Law of Diminishing Returns:
 Increasing successive units of a variable factor to a
fixed factor will increase output but eventually the
addition to output will start to slow down and would
eventually become negative.
 To prevent diminishing returns setting in, all factors
need to be increased  returns to scale (increasing,
constant or diminishing).
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2. Key Issues
2.2. Diminishing Returns (cont.)
Diminishing Returns:
Assume, the amount of land/plant was fixed.
Adding
labour and capital units would initially increase output
but the rate at which output would rise will start to
decline and eventually would become negative unless
the amount of land/plant was increased to accommodate
the increase in variable factors.
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2.2. Diminishing Returns (cont.) –
Graphical representation
Output
Total Product (TP)
Quantity of the
variable factor
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3. Efficiency
3.1. Basic Concept
 Efficiency in production will be reached when:
 one cannot produce the same level of output at
lower cost, i. e. using the minimal resources, valued
at their (factor) prices; or
 one cannot produce more output using the same set
of inputs.
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3. Efficiency
3.2. Productive Arrangements
 Lowest Cost:
 Productive efficiency can be achieved where the
same output could be produced at lower total cost.
 Achieved through re-organisation (e.g. to cell
production), investment in new technology, training
for staff and so on.
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3. Efficiency
3.3. Technical Requirements
 Minimum inputs:
 Technical efficiency can be achieved if the same
output can be produced using fewer inputs.
 Can be achieved using labour saving devices, more
efficient machinery, more effective re-organisation
of restructuring and so on.
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3. Efficiency
3.4. Allocative Efficiency
 Needs of Consumers  market mechanism  P = MC.
 P
… price of good / service.
 MC … marginal costs of good / service (= production cost for
one further unit).
 Allocative efficiency occurs where the goods and
services being produced match the demand by
consumers.
 P = MC  the value placed on the product
by the buyer (the price) equals the cost of the
resources used to generate the good / service.
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3. Efficiency
3.5. Social Efficiency
 Any constrained optimum can be viewed as a situation
where marginal cost (MC) equals marginal benefit (MB)
 MC = MB.
 MSC = MSB
 MSC … Marginal Social Costs.
 MSB … Marginal Social Benefit.
 Social efficiency occurs where the private and social
cost of production is equal to the private and social
benefits derived from their consumption.
 A measure of social welfare.
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4. Motives of Firms
4.1. Profit Maximisation
 The firms’ objective is profit maximization.
 Profit maximization implies cost minimization.
 Firms are constrained by the technology at any given
point in time.
 The main task of a firm is the optimal combination of
inputs.
 Profit (π) is defined as the difference between total
revenue and total cost.
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4. Motives of Firms
4.1. Profit Maximisation (cont.)
 Profit maximisation: assumed to be the standard motive of firms
in the private sector.
 A firm will maximize its profits by producing at an output level
where marginal cost (MC) is equal to marginal revenue (MR)
 MC = MR.
 The firm will continue to increase output up to the point where the
cost of producing one extra unit of output equals the revenue
received from selling that last unit of output.
 This assumes that firms seek to operate at maximum efficiency.
 For a firm operating in a perfectly competitive market: MR will be
equal to P  above condition (MC = MR) becomes to MC = P.
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4. Motives of Firms
4.2. Other Objectives of Firms
 Sales maximisation:
 Attempts to maximise the volume of sales rather
than the revenue gained from them.
 Share Price Maximisation:
 Pursuing policies aimed at increasing the share
price.
 Profit Satisficing:
 Generating sufficient profits to satisfy shareholders
but maximising the rewards to the managers /
board and avoiding attention from rivals or
regulatory authorities.
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4. Motives of Firms
4.3. Behavioural Objectives
 Modern firms have to attempt to match competing
stakeholder needs:
 Shareholders.
 Employees.
 Consumers.
 Suppliers.
 Government.
 Local communities.
 Environment.
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4. Motives of Firms
4.3. Behavioural Objectives (cont.)
 Firms may have to balance out their responsibilities:
 ‘Fat cat pay’ (Bezahlung Top-Manager).
 Management rewards – bonuses, etc.
 Social and environmental audits.
 Employee welfare.
 Meeting consumer needs.
 Paying suppliers on time.
 Satisfying shareholders about its policies, plans
and actions.
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5. Competition
5.1. Perfectly competitive markets
 Perfect competition:
– implies that no individual actor can influence the
market price;
– firms may have positive or negative profits in the
short run;
– leads to zero profits for each firm in the long run;
– will result in a Pareto optimal allocation of resources
in the long run.
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5. Competition
5.2. Imperfect competition
 Monopoly:
 Just one supplier (firm) in a market.
 The Price (quantity) will be higher (lower) than the price
(quantity) under perfect competition  “deadweight loss” (=
lower welfare).
 Monopolistic competition:
 Many firms with differentiated products.
 Oligopoly:
 Only a few firms (2, 4, …?) in a market  action of one firm will
be noticed by the other firm(s)  other firm(s) will react.
 Other forms, e. g. cartels, price leadership, spatial competition, …
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