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Edexcel Unit3 Companion 2010

Edexcel Unit3 Companion 2010

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Edexcel A2 Economics
Unit 3
Business Economics &Economic Efficiency
7
th
Edition: September 2009Author: Geoff RileyHead of Economics, Eton College
 
- 2 -tutor2uwww.tutor2u.net 
Edexcel A2 Economics – Unit 3: Business Economics & Economic Efficiency
I gratefully acknowledge the help of fellow EconoMax and Tutor2u Economics Blog authors MarkJohnston, Penny Brooks, Mark Johnston, Liz Veal, Mo Tanweer, Tom White and Bob Nutter for some ofthe ideas and arguments contained within this edition of the Edexcel Unit 3 course companion.Geoff Riley
Contents
Objectives .......................................................................................................................................................3
 
Company growth ...........................................................................................................................................6
 
Revenue ........................................................................................................................................................11
 
Costs ..............................................................................................................................................................14
 
Economies and diseconomies of Scale ....................................................................................................23
 
Productive and allocative efficiency .......................................................................................................37
 
Normal and supernormal profit ...............................................................................................................43
 
Profit Maximisation ....................................................................................................................................44
 
Barriers to market entry and exit ............................................................................................................50
 
Market concentration .................................................................................................................................54
 
Perfect Competition ...................................................................................................................................55
 
Monopoly .....................................................................................................................................................62
 
Monopsony ..................................................................................................................................................76
 
Oligopoly .....................................................................................................................................................78
 
Monopolistic Competition ..........................................................................................................................90
 
Contestable Markets ..................................................................................................................................92
 
Government intervention to maintain competition in markets ............................................................96
 
 
- 3 -tutor2uwww.tutor2u.net 
1.
 
Objectives
"There is one and only one social responsibility of business – to use its resources and engage in activitiesdesigned to increase its profits so long as it stays within the rules of the game, which is to say, engages in openand free competition without deception or fraud."
Source: Milton Friedman
 
Is the quote from Milton Friedman relevant today? The standard theory of the firm assumes thatbusinesses have enough information, market power and motivation to set prices that maximiseprofits.But this assumption is now criticised by economists who have studied the organisation and objectives ofmodern-day corporations. Not only do most businesses frequently move away from pure profit seekingbehaviour, many are nor organised and set up in a way where profit is not the only objective.There will always be a range of business objectives:1.
 
Profit maximisation2.
 
Revenue maximisation3.
 
Increasing and protecting market share4.
 
Surviving an economic downturn5.
 
Pursuing ethical business objectives6.
 
Providing a public service – see later sections on nationalised industries
Why might a business depart from profit maximisation?
There are numerous possible explanations. Some relate to the
lack of accurate information
requiredto set profit maximising prices. Others concentrate on the
alternative objectives of businesses
. Westart first with the effects of
imperfect information
. It might be hard for a business to pinpoint preciselytheir profit maximising output, as they cannot accurately calculate marginal revenue and cost. Oftenthe day-to-daypricingdecisions of businesses are taken on the basis of “
estimated 
demand conditions”or “rules of thumb”. Or a business might simply look to add a profit margin on top of their averagecost – this is known as “
cost-plus pricing
”.Secondly, most businesses are
multi-product firms
operating in a range of markets across countriesand continents – as a result the volume of information that they have to handle can be vast. And theymust keep track of the
ever-changing preferences
of consumers. The idea that there is a neat, singleprofit maximising price is redundant.
Behavioural Theories of the FirmBehaviouraleconomists
believe that modern large-scale businesses are
complex organizations
 made up various stakeholders.
are defined as any groups who have a vested interest inthe activity of a business. Examples might include:
o
 
Managers employed by the firm
o
 
Shareholders– people who have an equity stake in a business
o
 
Customers
o
 
The government and it’s agencies including local governmentEach of these groups is likely to have
different objectives
or goals at points in time. The
dominantgroup
at any moment can give greater emphasis to their own objectives – for example price andoutput decisions may be taken at local level by managers – with shareholders taking only a distantand imperfectly informed view of the company’s performance and strategy.If firms are likely to move away from pure profit maximising behaviour, what are the alternatives?

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