The Role of Business in the economy and Supply

The role of business in the economy (Syllabus)

1. Definition of a firm and an industry
2. A firm’s production decisions
• what to produce
• what quantities to produce
• how to produce
3. Business as a source of economic growth and increased productive capacity
4. Goals of the firm
• maximising profits
• maximising growth
• increasing market share
• meeting shareholder expectations
• satisficing
5. Efficiency and the production process
• productivity
• internal and external economies of scale
• diseconomies of scale
1. Firm versus Industry
A firm is any business organisation which uses resources to produce
GOODS and SERVICES to satisfy consumers’ needs and wants,
usually for a profit.

Groups of firms can be classified as industries. These groups can be

classified across various levels. For example:
❖ Services → Financial → Life Insurance
❖ Primary → Agricultural → Beef
Industry
Industry: group of firms producing a
similar range of goods and services:
1)Primary - extraction of natural
resources – mining and agriculture
2) Secondary – manufacturing –
producing finished or semi-finished
goods
3) Tertiary – provision of services;
includes construction, finance, IT,
health, retail
The Firm’s Production Process
A firm’s main production decisions include selecting the appropriate mix of inputs (e.g. raw
materials, intermediate goods, labour, capital and enterprise), then combining/adding value to
produce the final output (i.e. goods and services) that are demanded by consumers in product
markets.

Production
Resources/Inputs Outputs
process
2. A Firm’s Production Decisions

• What to produce
Largely determined by consumer demand
• What quantities to produce

• How to produce. Determined by firms based on the most e&e use of inputs
The role of business in the economy (Syllabus)
1.Definition of a firm and an industry
2. A firm’s production decisions
• what to produce
• what quantities to produce
• how to produce
3. Business as a source of economic growth and increased productive capacity
4. Goals of the firm
• maximising profits
• maximising growth
• increasing market share
• meeting shareholder expectations
• satisficing
5. Efficiency and the production process
• productivity
• internal and external economies of scale
• diseconomies of scale
3. Business as a source of economic growth

• Economic Growth = AD = C + I + G + (X – M)
• Historically: 60% + 25% + 25% - (10%)
• During Pandemic: 52% + 10% + 33% + 5%
• Business directly responsible for Business investment (I) – capital
goods; ability to increase productive capacity and produce more in
the future. (Note: nearly all investments in capital equipment are
imported (M))
• Employment of resources (including labour) means more people with
income/wages/profit and therefore firms significantly contribute
indirectly to Household consumption (C)
• Business profits allow governments to collect tax which allows for
expenditure (G)
• As business increases its international competitiveness it allows sales
to overseas markets (X)
• Business Profit encourages innovation and risk taking
• Increased output = HIGHER RATES of ECONOMIC GROWTH and
IMPROVED QUALITY OF LIFE
4. The goals of a Firm
They differ across small to incorporated firms, but generally share similar themes:
1) Profit maximization - (revenue less costs)
2) Maximising growth - (increase sales, how?)
3) Increasing market share - (proportion of revenue relative to its industry)
4) Meeting shareholder expectations - (for incorporated firms – they want p……
and d…………). For public companies, shareholder also want the s…….. P…….. to
rise so they can receive c……… g…….
5) Satisficing behavior – accepting that goals can be in conflict and to try and to
satisfy all goals
The role of business in the economy (Syllabus)
1. Definition of a firm and an industry
2. A firm’s production decisions
• what to produce
• what quantities to produce
• how to produce
3. Business as a source of economic growth and increased productive capacity
4. Goals of the firm
• maximising profits
• maximising growth
• increasing market share
• meeting shareholder expectations
• satisficing
5. Efficiency and the production process
• productivity
• internal and external economies of scale
• diseconomies of scale
5. Efficiency and the Production Process
Productivity

• Productivity Commission - Definition of Productivity:

‘Productivity (the ratio of output produced to inputs used) measures

how efficiently inputs, such as capital and labour, are used to produce
outputs in the economy”.
• “Productivity isn’t everything, but in the long run it is almost
everything” – Keating, 1991
• “there is only one source of ongoing higher rates of growth of real per
capita incomes, and that is higher rates of productivity growth” - Lowe,
2017
• "Competition policy is one of the surest ways to lift long-term
productivity growth and generate economic benefits that can be shared
by everyone” – Morrison, 2013
• “Where the hell have all the productivity improvements gone!” –
Brereton, 2014.
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= Output
Labour Inputs

= Output
All Inputs

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Contemporary:
- Labour productivity is stubbornly low: 1.0% in period since MIB; was 3% in 1990’s. Negative in the
past two years!!

- Increases in capital is often referred to as “Capital Deepening” - the idea that a firm or economy
investing in technology or equipment will benefit in the longer term. Outward shift in the PPF.

- We are going thru a period of ‘capital shallowing’ where R&D investment is down and is at its
lowest level since the GFC (PC Report 2023).

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A slowdown in the nation’s productivity rate is threatening to make every Australian thousands of dollars worse
off, almost double the size of the long-term budget deficit, driving up government debt and lower GDP by $60bn
less than expected by 2030.

Until the revised 2022/23 revised October budget, Treasury assumed productivity would grow at 2% a year, in
line with its average rate over the past 30 years.

But that 30-year average was boosted by a burst of productivity growth of 3% in the 1990s due to competition
and technological changes. Over the past 10 years, productivity in Australia has grown at 1.0% a year.

Productivity growth in the past decade has slumped to its lowest rate since the 1950s, according to the
Productivity Commission. It’s a global problem, with countries such as Canada, Britain, the United States and New
Zealand also noting a sharp productivity slowdown.

In nominal GDP per person terms, the lower productivity assumption translates into $2000 less for every
Australian.
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• A key goal of business is to produce as many goods and services using the
least amount of inputs. That is, become more productive.
• Using less inputs will reduce costs and therefore improve productivity.
• However, a reduction in Total Cost (TC) may not be possible or desirable if a
business is growing.
• Therefore, a better aim of production is to reduce the unit cost or average
cost of production

Total Costs (TC) = Average Cost (AC) = Unit Cost (UC)

Units of Output
• Unit costs are central to understanding the concept of economies of scale
 Internal & External Economies of scale
Most Common. Benefits of the firm getting bigger
Internal
Economies of
Scale
Benefits of the industry getting bigger
External

Internal Disadvantages of the firm getting bigger

Diseconomies
of Scale
External Disadvantages of the industry getting bigger

If reference is made to ‘economies of scale’, then it is usually a reference to internal economies of scale.
 Economies of scale - Internal

• In many situations, firms

are able to reduce their per AC falls as output
increases
unit costs of production as
their output increases.
• This is known as internal
economies of scale.
• Internal economies of scale
are experienced when
average costs per unit of
Technical Optimum
production FALL as output
INCREASES.
Why is this?
Why would average costs decrease as output increases?
Give reasons…….

https://www.tutor2u.net/economics/blog/economies-of-scale-
how-singapore-airlines-makes-19-million-meals-a-year
1. Firm is able to take advantage of specialisation of labour by
breaking up the process. A benefit of continuously repeating
production processes is that the firm gets more practice and
therefore more efficient
2. A large firm can invest in more efficient capital equipment with
more capacity.
3. A large firm can buy its raw materials in bulk and get a discount
(‘Bulk Purchasing’)
4. Large firms can put more resources in to Research and
Development (R&D)
5. Cheaper and easier to raise additional finance
The CSCL Globe was the largest container ship in the at the time of its launch in
November 2014,with a maximum capacity of 19,100 twenty foot containers.
The length of five football pitches. The economies of scale that allow a T-shirt
made in China to be sent to the Netherlands for just X (guess).
Oasis of the Seas

Think of 5 ways economies of scale

can be achieved.

Think about fixed costs or overhead

costs
 World’s biggest boats

Prelude Knock Nevis

• https://www.youtube.com/watch?v=wTPUjxe5W
QE&t=177s
Apple iPhones

Apple uses UPS to distribute iPhones across the globe. 474,000 phones one
plane. Only 41c per unit. Would be 21c if using sea freight. Why choose planes?
Economies of Scale in other sectors
Economies of Scale and the Car Industry (PMV)
Thailand manufactured 1,880,007
Australia manufactured 100,468 PMV in 2016
locally-made Holdens, Fords and
Toyotas in 2016. None in 2020.

Scale of operation is too small !!

Large Scale Production
Economies of scale - External
In addition to a firm’s own production process,
there are other external factors which impact its
costing.
External economies of scale occur outside of a firm
but within an industry. These are the advantages
that accrue to a firm because of the growth of the
industry in which the firm is operating and are not
the result of the firm changing its own scale of
operations.
Benefits include:
1. The clustering of businesses in a distinct
geographical location creates micro
economies e.g. software in Silicon Valley or
investment banks in the City of London
2. Skilled and specialised labour could be more
readily available
3. Improved infrastructure such as transport links
and other ‘technology’ infrastructure such as
increased bandwidth
4. The development of research and
development facilities in local universities that
several businesses in an area can benefit from
5. The relocation of component suppliers and
other support businesses close to the centre
of manufacturing are also an external cost
saving
Diseconomies of scale - Internal
AC or UC increases as
• A firm cannot continue to output increases

grow indefinitely and benefit.

They will eventually reach a
point where costs of
production will start to rise.
Technical Optimum

• This is called internal

diseconomies of scale
Reasons for Internal diseconomies of scale

1. Decrease in managerial and administrative efficiency:

• Management can lose touch with day to day running of the business
(poor communication, ‘ivory towers’)
• Workplace relations issues as management doesn't know the staff
personally. Lack of motivation
• Loss of agility
2. Lots of red tape - too much duplication of paperwork
Diseconomies of scale - External
These are the disadvantages faced by a firm because of the growth
of the industry in which the firm is operating. Reasons include:
1. More competition for inputs. Can lead to higher input costs and
scarcity (eg. rents in Silicon Valley)
2. Increased traffic congestion e.g. Macquarie Park
 Supply
(from Topic 3)
Syllabus
Supply
• law of supply, individual and market supply, the supply curve
• factors affecting supply – price/cost of factors of production, prices of
substitutes and complements, expected future prices, number of
suppliers, technology
• movements along the supply curve and shifts of the supply curve
Price elasticity of supply
• elastic supply, inelastic supply
• factors affecting elasticity of supply (no calculations are required)
Supply
Supply refers to the quantity of a good or service that firms are willing and able to
offer for sale at a given price, at a given point in time.

● If prices increase, supply by firms for that good or service increases.

● If prices decrease, the supply by firms for that good or service decreases.

This is known as the ‘law of supply’ (usually expressed in terms of price increase)

From the table below, a supply curve can be drawn.

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Supply

35
Contractions and Expansions in Supply

A ‘contraction’ of supply - refers to when the PRICE of a good or

service decreases, then LESS QUANTITY will be supplied by
firms, which means the supply moves down along the curve.

● This reduces the amount of profit businesses can make,

hence they will switch to other more profitable goods and
services

An ‘expansion’ of supply - refers to when the PRICE of a good or

service increase, then MORE QUANTITY will be supplied by
firms, which means the supply moves up along the curve.

● This makes sense as business will have more opportunity

for higher profits hence will start producing more

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Shifts in the Supply Curve

A supply curve will ‘shift’ to the left or right

when something OTHER THAN THE PRICE
of the good itself changes.

● A shift to the right indicates an

‘increase in supply’, meaning more of
a good will be supplied at every price
level.

● Conversely, a shift to the left indicates

a ‘decrease in supply’, indicating less
of a good is supplied at every price
level.

The next slide indicates the reasons

leading to shifts of the demand curve.

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Factors for an increase/decrease or shift in Supply

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 Summary - Factors Affecting Supply
Movement
1. Price of THE good Along the
Curve
2. Cost of factors of production
3. Quality of the factors of production
4. Number of suppliers Shifts of the
5. Technology Curve
6. Climatic conditions
7. Prices of other products that the
firm could make
8. Expected future prices
One more time…………
Contraction of supply Expansion of supply
A decrease in the price of a good An increase in the price of a good
causes a contraction in quantity causes an expansion in quantity
supplied. supplied.
S
S

P P1

Expansion
Contraction P
P1

Q1 Q Q1
Q
 Shifts of the Supply Curve
• Any factor that influences supply, other than the price of THE good,
causes a shift in the supply curve.
• Can either INCREASE SUPPLY OR DECREASE SUPPLY

Increase in
supply
Decrease
in supply
Increase in Supply
1. An improvement in the technology used in the production process
(eg. automated pineapple harvester, robotics, AI)
2. A fall in the cost of factors of production (eg. pineapple pickers) or
an increase in the resources available
3. Price of pineapples expected to rise
4. More pineapple growers enter the market
5. A fall in the price of other goods, which makes production of other
goods less profitable (consider a farmer who has choice between
mangoes and pineapples. What happens if the price of mangoes
fall?)
Decrease in Supply
1. A certain technology no longer being available
2. A rise in the cost of factors of production or a decrease in the
quantity of resources available
3. Fall in expected future prices
4. Regulations restricting the sale of a good (fireworks)
5. A rise in the price of other goods that the supplier can produce
Syllabus (from topic 3)
Supply
• law of supply, individual and market supply, the supply curve
• factors affecting supply – price/cost of factors of production, prices of
substitutes and complements, expected future prices, number of
suppliers, technology
• movements along the supply curve and shifts of the supply curve
Price elasticity of supply
• elastic supply, inelastic supply
• factors affecting elasticity of supply (no calculations are required)
 Price Elasticity of Supply (PES)
• PES measures the responsiveness of the quantity supplied of a product
to changes in the price of that product.
• According to the law of supply, an increase in price causes an increase
in quantity supplied (PES is positive)
• PES is the % change in the QS / % change in Price
• If the increase in the amount supplied
(10%) is proportionately greater than the
price increase (5%), then PES is relatively
elastic
• If the increase in the amount supplied
(5%) is proportionately less than the
price increase (10%), then PES is
relatively inelastic
• If same, unit elastic
Factors Affecting Elasticity of Supply
1. The ability to hold stock or inventory
2. Whether the supplier has excess capacity
3. Time lags after price change (immediate term,
longer term)
1. The ability to hold stock or inventory
• If a good can be held in stock, then producers can store
goods if prices fall or they can more readily provide (stored)
stocked if prices rise.
• Therefore, the more able to be stored, the more elastic the
supply
• The ability to store depends on the good. For example, if
the price of fresh prawns increase, producers are not able
to respond quickly by using stock (the supply of prawns is
therefore inelastic)
2. Excess Capacity
• If a producer is not currently at full capacity (eg. Staff and
machinery), then they will be more able to respond if
there is a price increase.
• Therefore, supply is relatively elastic to price movements if
there is spare capacity
• If at full capacity already, the response of the producer to
a price increase will be relatively inelastic

• For example, a machine can make 1000 ducks each hour. A

business is making 500 each hour. What sort of elasticity if
price increases? What if there was a price increase if they
were making 1000 each hour?
3. Time Lags after Price Change
• Generally speaking, the longer a producer has to respond to
a price change, the more elastic is the supply
• In the period immediately after a price change, supply is
virtually perfectly inelastic (even if excess capacity)
• Price elasticity of supply increases over time, but in the short
run it tends to be relatively inelastic. In the long run, it is
relatively price elastic as producers can make changes to
inputs and production output.