Unit 3: Business Behaviour

These categories answer different questions. A private business can be for-profit or not-for-profit; a co-operative is usually private-sector; a joint venture describes shared ownership of a project or business.

Business size can be measured by employees, sales revenue, capital employed, assets, output or market share. Rankings can differ because each measure captures a different dimension.

First decide whether growth is internal or involves another firm. If it is integration, locate both firms in the production chain and compare their industries and stages.

Synergy exists when the combined business creates more value or lower cost than the firms could separately, but it requires compatible resources and effective integration.

Constraints interact: a small market weakens expected cash flow, which makes finance harder to obtain; limited finance then prevents marketing or capacity investment that could reach a wider market.

Remaining small can be a deliberate, profitable strategy rather than failure. Growth becomes attractive when expected extra revenue and strategic benefits exceed financing, coordination and risk costs.

Cost savings benefit consumers only if competition or strategy causes them to be passed on. Higher market power may let the firm retain savings as profit instead.

A demerger separates one business into two or more independent businesses, usually by distributing or selling ownership of a division.

A demerger creates value when focus and reduced complexity outweigh lost synergies and separation costs. The result depends on whether the original combination genuinely suffered diseconomies or strategic mismatch.

Objectives can change with ownership, competition, finance, market entry and time horizon. A firm may pursue sales now to build market share and profit later.

In many large companies, shareholders own the firm but professional managers control daily decisions. This divorce of ownership from control creates a principal-agent relationship: owners are principals and managers are agents.

Managers may have more information and pursue salary, status, growth, job security or easier targets rather than owners' preferred profit and shareholder value. Monitoring is costly, so objectives may shift toward revenue, sales or satisficing.

Use the stated objective to select its condition, locate the corresponding output, then read price from the average-revenue/demand curve when required.

Profit is $TR-TC$, revenue is $P imes Q$, and sales volume is quantity. The three maxima generally occur at different outputs and prices.

Total revenue is all sales income, average revenue is revenue per unit and marginal revenue is the addition to total revenue from one more unit. For a single-price firm, AR equals price and is its demand curve.

At 100 units sold for $6 each,$TR=$600 and$AR=$6. If selling unit 101 raises TR to$604, that unit's $MR=$4.

TR changes according to whether the percentage quantity response outweighs the percentage price change. On a downward-sloping linear demand curve, MR is positive in the elastic range, zero at unit elasticity and negative in the inelastic range.

In the short run at least one factor is fixed. With a constant wage per variable worker, marginal cost is inversely related to marginal product: when an extra worker adds more output, the labour cost per extra unit falls.

Initially specialisation may raise marginal product, so MC falls. Once diminishing marginal productivity begins, MP falls and MC rises. The same productivity forces help AVC become U-shaped; ATC is also U-shaped but includes AFC.

With at least one fixed factor, adding successive units of a variable factor eventually causes marginal product to fall, holding technology and the quality of inputs constant.

Early workers may specialise and use fixed capital more fully. Beyond some point, each additional worker has less fixed capital or space to work with, so the extra output from that worker declines.

When each extra input unit adds less output but still costs the same, the cost of producing an additional unit rises: diminishing returns cause the upward-sloping section of MC.

If $TFC=$500 and at 200 units $TC=$2,500, then $TVC=$2,000, $AFC=$2.50, $AVC=$10 and $AC=$12.50. If TC rises to $2,620 at 210 units,$MC=$120/10=$12 per extra unit.

In the short run at least one input and some cost are fixed, creating TFC. In the long run all inputs are variable, so the firm chooses scale and there is no fixed input in the planning decision.

LRAC shows the lowest attainable average cost for each output when all inputs and plant size can be changed. It is commonly U-shaped because scale benefits are eventually outweighed by organisational costs.

Minimum efficient scale (MES) is the lowest output at which a firm reaches the minimum point, or minimum flat range, of its long-run average cost curve and has exhausted available economies of scale.

A high MES relative to market demand favours a few large firms because entrants must achieve substantial output to match incumbents' unit costs. A low MES allows smaller firms to compete efficiently.

On an LRAC curve, move from low output along the falling section; the first output at which minimum LRAC is reached is MES. Output beyond MES does not create further scale cost savings.

Internal economies cause movement down a firm's LRAC as its own output rises. External economies lower the attainable costs of firms at each output, shifting their cost conditions downward.

As an industry concentrates or grows, workers, suppliers, infrastructure and institutions specialise around it. These shared resources can reduce LRAC for many firms without each firm expanding.

If these organisational costs grow faster than output, LRAC rises. Decentralisation, better information systems and stronger accountability may delay or reduce the problem.

Normal profit is the minimum return needed to keep enterprise in its current use and is included in economic cost. It is therefore zero economic profit, not zero accounting income.

If $AVC<AR<AC$, the firm makes a loss but continues in the short run because operating loses less than shutting immediately; it exits in the long run unless conditions improve.

Competition can strengthen cost and allocative discipline; market power can weaken it but may finance scale and innovation. Judge actual incentives, entry threats and regulation rather than the market label alone.

Rank firms by the same market-share measure, select the largest $n$, add their percentage shares and include the % unit. If data are sales values, calculate each share against total market sales first.

If the four largest shares are 24%, 18%, 13% and 9%, $CR_4=24+18+13+9=64\%$. A fall from 72% to 67% is a 5 percentage-point fall, not a 5% fall.

A high n-firm concentration ratio shows that a small group controls a large share of the defined market, suggesting oligopoly and possible market power. A low ratio suggests a more fragmented market.

Each firm chooses output where $MC=MR=P$ with MC rising. In the short run, price may lie above, equal to or below AC, creating supernormal profit, normal profit or loss.

Supernormal profit attracts entry, shifting market supply right and lowering price; loss causes exit, shifting supply left and raising price. With unchanged costs, entry/exit continues until firms earn normal profit where $P=AR=MR=MC=AC$.

A firm's output can fall as entry raises total industry output. The long-run result depends on free entry/exit and no permanent cost advantage.

At a short-run competitive equilibrium, a producing firm chooses the rising part of $MC=P$, so the last unit's marginal benefit equals marginal cost and allocative efficiency is achieved under the model assumptions. The firm need not produce at minimum AC, so productive efficiency is not guaranteed.

Entry after supernormal profit and exit after loss change market supply and price. With unchanged costs and free entry and exit, adjustment ends at $P=MC$ and minimum $AC$: allocative and productive efficiency coincide with normal profit.

Successful differentiation makes substitutes less close, shifts demand right and can reduce price elasticity, allowing a higher price or market share. It also has development and promotion costs.

The firm maximises profit at $MC=MR$ and reads price from its downward-sloping AR curve. It can earn supernormal profit, normal profit or loss in the short run.

Supernormal profit attracts differentiated rivals, reducing each incumbent's demand until AR becomes tangent to AC at the profit-maximising output. The firm then earns normal profit in long-run equilibrium.

Short-run loss causes firms to exit; remaining firms gain demand until normal profit is restored, assuming free entry/exit and unchanged conditions.

The static inefficiency may be offset partly by greater product variety and choice, which standard $P=MC$ comparisons do not fully capture.

A two-firm/two-outcome payoff matrix shows that each firm's best action depends on its rival. Both may gain from maintaining high prices, yet each can have an incentive to cut price secretly, creating a prisoner's-dilemma outcome.

Collusion is more stable with few firms, repeated contact, transparent prices and credible punishment; it weakens with cheating incentives, demand shocks, new entry and legal penalties.

Price fixing typically moves price above competitive levels and restricts output, transferring surplus to producers and creating deadweight loss.

Consumers may gain lower prices temporarily, while firm margins, supplier payments and employment can fall. Predation and limit pricing work only if the incumbent can sustain the strategy and entry remains deterred later.

These methods aim to shift demand right or make it less price elastic, increasing sales or pricing power without cutting price.

Price competition is attractive when costs can sustain cuts; non-price competition is stronger when differentiation creates lasting value. Outcomes depend on pass-through, quality truthfulness and market power.

Scale economies/natural-monopoly cost conditions, patents, licences, control of essential inputs, network effects, branding, strategic pricing and capital requirements can protect monopoly power.

Specialised infrastructure, contractual obligations and sunk advertising/R&D make exit costly, reducing hit-and-run entry because entrants risk unrecoverable loss.

Stronger barriers make demand less contestable and allow supernormal profit to persist; innovation, regulation or technological change can weaken them.

A monopoly chooses output where $MR=MC$ with MC rising, then reads the highest price consumers will pay from the AR/demand curve at that output.

Compare price/AR with AC: supernormal profit per unit is $P-AC$, so total supernormal profit is $(P-AC) imes Q$. High barriers can sustain it in the long run.

Because the monopoly faces downward-sloping demand, MR lies below AR: selling more usually requires a lower price, including on earlier units.

Consumers benefit only when cost savings, investment or service obligations are delivered and passed through. Regulation, ownership, objectives and contestability determine the balance.

A natural monopoly exists when economies of scale are so extensive relative to market demand that one firm can supply the whole market at lower average cost than two or more firms.

Large fixed infrastructure and low marginal cost make LRAC fall across relevant demand. One network avoids costly duplication, but an unregulated provider may restrict output and charge above cost.

Profit-maximising discrimination sets higher price in the submarket with less elastic demand and lower price where demand is more elastic, subject to marginal conditions.

A pure monopsony has one buyer; monopsony power exists when a buyer can push input price or wage below the competitive level.

In a labour monopsony, the buyer hires where marginal labour cost equals labour demand and pays the wage on labour supply, typically giving lower wage and employment than competition.

Contestability concerns the threat of potential competition, not the current number of firms. Even a concentrated market can behave competitively if entry is credible.

If supernormal profit or a high price attracts rapid entry, incumbents may use limit pricing, control cost, improve quality and innovate to keep entrants out.

The credible threat reduces the ability to sustain supernormal profit even when no entrant is currently present. Firms may accept normal or lower profit to protect long-run market share.

This discipline is stronger when entrants can reach scale quickly, consumers can switch and sunk costs are low; branding, capacity constraints or retaliation weaken it.

Benefits depend on entry being credible and sustainable, not merely legally permitted. Excessively easy hit-and-run entry can weaken investment in fixed networks or quality.

A sunk cost is an expenditure that cannot be recovered on exit, such as market-specific advertising, specialised research or non-redeployable equipment.

A potential entrant compares expected profit with the risk of losing sunk investment. Larger sunk costs make entry and hit-and-run exit riskier, so incumbents can sustain higher prices/profits with less threat.

Labour demand is derived demand: a firm wants workers because their output can be sold. Stronger demand for the final product raises the value of the extra output workers produce and shifts labour demand to the right; weaker product demand shifts it left.

The elasticity of demand for labour measures how responsive employment is to a change in the wage rate. Demand is more elastic when a given percentage wage change produces a larger percentage change in labour demanded.

The effect must be analysed for the particular occupation: population growth does little for an occupation if workers lack its qualifications, location or legal permission.

Elasticity of labour supply measures how responsive the quantity of labour supplied to an occupation is to a change in its wage rate. Supply is more elastic when workers can enter, leave or change hours readily.

In a competitive labour market, equilibrium is where labour demand equals labour supply. The equilibrium wage is the price of labour and equilibrium employment is the quantity hired and offered at that wage.

Product demand, productivity and product price can shift labour demand. Population, migration, participation, tax/benefit incentives, regulation and mobility can shift labour supply. Different occupations therefore reach different wage-employment equilibria.

If demand and supply shift together, one result may be determinate while the other is ambiguous. For example, rightward shifts of both curves raise employment, but the wage rises only if the demand shift is relatively larger.

Public-sector and state-owned-enterprise wages reflect labour demand and supply, but government objectives and institutions can prevent the wage from being set only by short-run profit maximisation.

Compare total compensation as well as salary: pensions, job security, hours and leave can offset part of a cash-wage difference. Private-sector profitability and competition also vary, so either sector may pay more.

Geographical immobility occurs when workers cannot or will not move between locations to take available jobs, even when unemployment and vacancies coexist in different regions.

Workers may remain unemployed or accept lower wages while firms elsewhere face vacancies, higher recruitment costs and capacity constraints. Persistent regional wage and unemployment gaps create structural unemployment and reduce potential output.

Occupational immobility occurs when workers cannot move readily between types of job because their skills, qualifications or experience do not match available vacancies.

A changing economy can then have unemployment in contracting occupations alongside vacancies in expanding ones. Firms face recruitment costs and wage pressure, while workers lose income and human capital; structural unemployment reduces output and tax revenue.

Government intervention has a case when an unregulated product market creates market power or another market failure, so private decisions produce a lower-welfare outcome than a feasible policy could achieve.

The economic case is comparative: estimate the market failure, choose a targeted measure, then compare its expected welfare gain with enforcement cost, information limits and unintended effects.

Choose the instrument that matches the failure: price rules address excessive charges, standards address quality, and merger control protects the competitive structure before dominance becomes difficult to reverse.

The strongest measures reduce entry, expansion and exit barriers. More firms are not enough if entrants face high sunk costs, cannot reach consumers or cannot compete on equal terms.

Protection is most justified where a dominant buyer or employer can impose terms because suppliers and workers have few alternatives. The policy should raise bargaining power or enforce minimum conditions without destroying the demand it seeks to protect.

Evaluate every intervention through the same causal chain: identify the instrument and binding constraint, predict the firm's response, then trace price, profit, efficiency, quality and choice before adding the policy's information and enforcement limits.

Measures interact: a price cap can help consumers immediately but undermine quality if the permitted revenue cannot finance maintenance; pairing price and quality regulation can control that trade-off but raises monitoring cost.

A mis-set price cap can permit exploitation or make a viable firm unable to invest. A weak quality rule can create compliance paperwork without better outcomes. These are mechanisms of government failure, not just administrative inconvenience.

Government intervention has a case when labour-market outcomes reflect market failure or exploitation rather than only differences in worker productivity and preferences.

Judge each policy by whether it is binding, whom it covers, labour-demand and labour-supply elasticities, enforcement, time horizon and the original market structure. The same minimum wage can have different employment effects in competitive and monopsonistic markets.