Unit 4: The Firm

 

Differences in wage levels:

There is a wide range in the amount that individuals get paid for the work they do. Various reasons exist:

• Supply and demand of labour: If workers are highly demanded and in low supply then firms will offer high wages to attract workers. The opposite is also true.

• Skill level: Highly skilled workers are likely to earn high wages as few people can do what they do (doctors, vets etc).

• Experience: Workers that remain in a job generally receive higher pay as they gain more experience

• Geographical location: Some workers receive higher wages to make up for a higher cost of living in some parts of a country (examples London in the UK, Yangon in Myanmar).

• Danger factor: Jobs that have risks associated often pay higher wages (fireman, soldiers etc).

• Trade union influence: Workers that can collectively bargain collectively (teachers unions etc) can demand higher wages.

• Government policy: Some governments impose minimum wage levels.

  Different types of Firms:

  Sole Trader:

• Owned by one person

• Low setup costs and small in size

• Owner gets all the profits and is liable for all the losses.

• Limited financial capacity (lack of capital).

• Owner may lack some skills.

• Examples are builders, carpenters and mechanics.

  Partnerships:

• Minimum of two partners

• Increased financial capacity, but still quite weak

• Increased skill set

• Partners share profits and losses

• Examples are Accountants, Architects and Solicitors

  Co-operatives

• Jointly owned by members

• Run for the benefit of the members

• Bulk buy to allow low prices

• Workers co-ops share profits and decision making

• Housing co-ops buy and manage housing

  Private Limited companies

• Financial capital divided as shares

• Shares sold privately, not on stock market

• Share holders only have limited liability

• Shares are often sold to friends and family

• Limited ability to raise finance due to shares being limited to private sale

  Public Limited Companies

• Financial capital divided as shares

• Shares sold to public on stock exchange

• Can raise large amounts of finance through share sales

• Often large in size

• Admin costs of initial prospectus and sending annual accounts reports to shareholders

• Owned by shareholders

• Controlled by a Board of Directors

   

  Fixed costs versus variable costs:

  Fixed costs: These are costs that do not vary with the output such as rent, interest on loans etc. This means that the Total Fixed Costs (TFC) is a horizontal straight line.

  The Average Fixed Cost (AFC) line is a sloped straight line.

  AFC = TFC/output quantity

  Example:

  If fixed costs are $10 and one item is produced then the AFC is $10

  However, if two items are produced then the AFC is $5, three items it will be $3.33 etc

   

  
  

   

  Total Variable Costs: These are costs that change as output changes. Examples of these are raw materials, wages, and utility bills.

  As output increases Total Variable Costs (TVC) increase.

  Average Variable Costs (AVC) initially fall as productivity of workers increase and the firm benefits from economies of scale but these diminish and may reverse with increased output.

  AVC = TVC/output quantity

   

  
  

  Marginal Utility:

   

  

  Measuring the size of a Firm:

  Three ways of measuring the size of a firm:

• Number of employees

• Value of output

• Financial capital

  Size advantages:

• Small firms can be more personal, flexible and specialized

• Large firms have more financial capital, benefit from economies of scale, and can attract highly skilled employees

• Firms often start on a small scale and may then expand if that is the owner’s ambition. They firm can only expand if the market is big enough as well.

  Integration as means of growth:

  Horizontal Integration:

• Merging of firms at the same stage of production

• May benefit from increased economies of scale

• Rationalization of staff and capital to increase efficiency

• Example: Two tire companies, Goodyear and Dunlop merging with each other

  Vertical Integration:

• Merging of firms producing the same product but at different stages

• Backward vertical integration: Merging with a firm that supplies your raw materials/components

• Forward vertical integration: Merging with a firm that sells your product/commodity

  Growing Internally:

• Expansion of the current market – increased output

• Increasing market share – taking advantage of a growing market or attracting consumers from other competitors

• Diversification into other products – establishing a presence in new markets

  Economies of scale:

  Average cost reductions from increasing scale of production:

• Buying: Bulk buying often results in cheaper costs per item

• Selling: It generally costs less on average to process and transport large orders compared to many small orders

• Management: Increased output allows more specialist workers (accountants, designers) to be employed who increase efficiency and are cheaper than contracting in these services

• Financial: Large firms often get lower interest rates on loans (making them cheaper) as the banks perceive the risk of the loan to be lower

  Diseconomies of scale:

  These are when the average cost per item increases from increasing the scale of production:

• Management: It can become more difficult and complex to control and manage larger firms. This leads to inefficiency and more administration costs

• Communication: Increased size and number of employees makes it increasingly difficult to keep everybody informed.

• Rising labour costs without increasing capital investment (employing more workers but not investing in more machines).

   

  Industrial Classification:

• 
  Primary Industry: Extracting raw materials (farming, fishing, forestry, mining)

   

• 
  Secondary Industry: Manufacturing and Construction.

   

• Tertiary Industry: Service provisioning (lawyers, police, teachers, doctors)

   

  
  

   

   

   

   

   

	Less economically developed country (LEDC)	Newly industrialized country (NIC)	More economically developed country (MEDC)
Primary Industry	High amount	Medium amount	Low amount
Secondary Industry	Low amount	Low amount	Medium amount
Tertiary Industry	Very low amount	Low amount	High amount

 

Perfect Competition:

• Free entry to and exit from the market for firms

• Many firms in the market – none big enough to influence the market price through change of supply

• Products in the market must be identical (for instance vegetables) so that consumers choice is not based on the origin of the product

• Perfect information for buyers and sellers

• Firms don’t use price as a method of increasing will lose all customers and a price decrease will result in not enough profit to stay in business

• Firms attract customers through quick reaction to market changes and product development

• Firms only make “normal profits” in the long run since any increase in profit levels (increased demand) will attract more firms to supply in the market, which will lower the price and subsequent profits

• A decrease in demand leads to firms making a loss. Some firms will leave the industry which reduces supply. Prices will rise again and firms will make a “normal profit”

  Monopoly:

• Firm has close to 100% share of the market

• Very difficult for other firms to enter the market (scale of production allows lower costs)

• Being the only supplier they decide output and therefore prices

• Monopoly firms can earn “supernormal profits” in the long run due to lack of competitors

• Monopoly firms can either:

  • Set the price of the product and then supply what the market demands

  • Set the quantity they will supply and accept the price the market decides

• Lack of competition can lead to:

  • Inefficiencies in monopoly firms

  • Possibly poorer quality products as there is no alternative

  • Higher prices as monopoly firms can restrict the supply of a product