IGCSE O Level Economics Chapter 4.4 Competition

Why Firms Compete

• Firms compete to increase their customer base, sales, and market share, achieve product superiority, enhance their image, and ultimately increase profits.

Benefits of Competition

• Encourages profit-seeking firms to use their resources efficiently to compete on prices and products, benefiting consumers.

Types of Competition

• Price competition: competing with rival suppliers on product price.
• Non-price competition: competing on all other product features, such as new product development, after-sales care, promotions, advertising, in-store displays, and competitions.

Market Structure

• Characterized by the number of firms competing to supply, the degree of competition, product differentiation, and ease of entry for new firms.

Perfect Competition

• Based on 4 assumptions: many buyers and sellers, perfect knowledge, no barriers of entry/exit, and homogenous output.
• Firms are price takers, and individual firms have no control over market price.

Monopoly

• A single firm or group of firms with sufficient market power to restrict competition and set the market price.
• May restrict supply to force up the market price and earn abnormal/supernormal profits.
• Can abuse its market power to restrict market supply, restrict competition and consumer choice, and cut product quality to save costs.
• May lead to x-inefficiency and require regulation.

Problems with Monopolies

• Abuse of market power, x-inefficiency, and need for regulation.

Regulating Competition

• Competition policy measures: regulating prices of monopolies, imposing fines, and breaking up monopolies into smaller firms.
• Consumer protection laws protect consumers from exploitation and harmful business activities.

Not all Monopolies are Bad

• A monopoly can still act competitively and be good for consumers if it is a more efficient producer or invests profits in new product developments.
• Abnormal profits can be a reward for significant investment risks, leading to revolutionary products.

Exam Questions

• Discuss whether the advantages of a monopoly are greater than its disadvantages.
• Explain how firms can grow in size, and discuss whether some large firms might benefit from reducing their size.
• Explain how firms may have benefited from horizontal and vertical integration.
• Discuss whether firms always benefit from growing larger.

Organization of Production

• Sole Trader: A business owned and run by one person, with unlimited liability.
  • Pros: easy to set up, full control, and all profits belong to the owner.
  • Cons: unlimited liability, all losses are borne by the owner, and lack of continuity.

Labour Market

• Demand for Labour: The demand for labour is a derived demand, meaning it depends on the demand for the product or service produced.
  • Factors that determine demand for labour:
    • Government policy in relation to the public sector
    • Regional policy to encourage firms to locate in particular areas
    • Tax relief to firms to encourage production and employment
• Supply of Labour: The supply of labour is affected by factors such as:
  • Effective training and retraining schemes
  • Good education system
  • Minimum wage legislation

Production

• Production Process: The process of transforming inputs (land, labour, and capital) into outputs (goods and services).
  • Value added: the difference between the market price paid for a product and the cost of the natural and man-made materials used to make it.
  • Value added = profit + wages
• Industrial Sectors:
  • Primary sector: extraction and production of natural resources
  • Secondary sector: construction and manufacturing
  • Tertiary sector: personal and business services

Aims of Production

• Aims of Private Sector Firms: Maximize profit, which is a surplus of revenue over costs.
• Aims of Other Organizations:
  • Charities: help people or animals in need, or protect the natural environment
  • Not-for-profit organizations: run for the benefit of their members, with any surplus reinvested in the organization or used to lower prices
  • Public sector organizations: provide public services, such as healthcare and education

Productivity

• Productivity: Measures the amount of output (goods and services) produced from a given amount of input (land, labour, and capital resources).
• Improving Productivity: Strategies to increase productivity include:
  • Training employees to improve skills
  • Rewarding increased productivity with performance-related pay
  • Increasing job satisfaction
  • Introducing new production processes and technologies
  • The division of labour and factor substitution

Costs of Production

• Fixed Costs: Do not vary with output, e.g., rent, insurance premiums, and loan repayments.
• Variable Costs: Vary directly with output, e.g., cost of materials, labour, and other inputs.
• Total Cost: Total fixed cost + total variable cost
• Average Cost: Total cost ÷ number of units produced
• Break-even Level of Output: Where total revenue equals total cost.

Starting a Business

• An entrepreneur combines and organizes resources in a firm for the purpose of carrying out productive activity or business.
• Firms can take different legal forms depending on how they are owned, controlled, and financed.

Types of Business Organization

Sole Trader

• A sole trader or sole proprietorship is a business owned and controlled by one person.
• It is the oldest and most popular form of business organization.
• Financial liability is unlimited, meaning the business owner's personal possessions can be sold to repay business debts.

Partnership

• A partnership is a legal agreement between two or more people to own, finance, and run a business.
• It is popular among professionals such as solicitors, accountants, and veterinary surgeons.
• Financial liability is unlimited.

Joint-Stock Company

• These companies sell shares in their ownership to raise permanent capital.
• Shareholders are the owners of joint-stock companies.
• Shareholders elect directors to run the company from day to day.
• The company has a separate legal identity from its owners.
• Shareholders have limited liability.

Private Limited Company

• A private limited company is a type of joint-stock company.

Public Limited Company

• A public limited company is a type of joint-stock company.

Multinational

• A multinational is a firm that operates in more than one country but has its headquarters based in its country of origin.
• Multinationals have a huge global customer base and revenue potential.
• They can minimize transport costs, wage costs, and average production costs.
• They can raise significant capital for business expansion, R&D, and to employ highly skilled labor.

Cooperatives

• A cooperative is owned by its members for mutual benefit.
• There is a one member, one vote policy.
• Principles: mutual aid, mutual responsibility, and mutual respect.
• Values: self-help, self-responsibility, democracy, equality, equity, and solidarity.
• A cooperative is different from other types of business because it is owned and controlled by its members.

Public Corporation

• A public corporation is a business-like public sector organization created to carry out a particular public sector function or operate under governmental control.
• Examples include municipal water companies, public health services, and central banks.
• Some public corporations may be run for profit.
• They are responsible for the day-to-day running of nationalized industries.

Measuring the Size of Firms

• The size of firms can be measured in various ways, including:
• Size of workforce
• Capital employed (amount of money invested in productive assets)
• Market share (dominance in sales in a particular market)
• Internal organization (division of labor into different departments)

Types of Firm Growth

• Internal growth (organic growth): expansion of scale of production through purchase of additional equipment and increasing premises
• External growth: integration of two or more firms to form a larger enterprise
• This can be through merger or takeover
• Examples of external growth:
  • Just Eat acquiring Hungry House
  • Expedia acquiring Orbitz Worldwide
  • BT acquiring EE
  • etc.

Types of Integration

• Horizontal integration: between firms producing the same type of good or service
• Vertical integration: between firms at different stages of production
• Lateral integration: between firms in different industries at the same or different stages of production

Economies of Scale

• Cost savings from increasing the scale of production in a firm or industry
• Internal economies of scale:
• Purchasing economies (e.g. discounts for bulk purchases)
• Marketing economies (e.g. mass advertising; own distribution network)
• Financial economies (e.g. ability to borrow more at lower interest rates)
• Technical economies (e.g. ability to afford and employ advanced equipment)
• Risk-bearing economies (e.g. offering a range of different products)
• External economies of scale:
• Access to a skilled workforce
• Ancillary firms providing specialized equipment and business services
• Joint marketing benefits
• Shared infrastructure

Disadvantages of Firm Growth

• Firms can experience problems if they expand too much and too quickly, leading to:
• Diseconomies of scale
• Falling productivity and rising average costs
• Problems with internal communication and coordination
• Industrial disputes and uninteresting work tasks

Why Firms Remain Small

• Firms may remain small due to:
• Small, local, or specialized niche markets
• Inability to raise enough capital to expand
• Owner preference for keeping the business small
• Ability to provide personalized goods and services