Issues on Companys Market Performance - Assignment Example

4. What is the level of profit in a monopoly? How can a monopolist make profits in the long run? Monopoly is the form of market where there is a single firm catering a good for which there are no close substitutes to a large number of buyers. There are strong barriers to entering the market for a new firm. So, the sole firm is the industry and it faces a downward sloping industry demand curve. As a result, unlike perfect competition where all units can be sold at the same market price, here the firm has to gradually lower the price to ensure increase in sales. So, here the MR curve shall lie below the demand curve. However being the sole firm in the industry, a monopolist has market power in that it can choose the price himself. In fact the choice problem of the monopolist is to choose the per-unit price and quantity of output to maximise profits. This is achieved by producing that level of output (Qm) for which the MC = MR (with the MR being intersected by the MC from below as a second order condition). The price charged will be Pm as it can be seen from the demand curve that it is what the consumers shall be willing to pay for each unit if Qm is the available output in the market. Here the profit level shall be supernormal (represented as the shaded area in the diagram) i.e, over and above the normal profits. The absence of close substitutes allows the monopolist to charge a price high enough that ensures supernormal profits. However one should note that the monopolist can actually be bearing losses as well in the short run. This occurs simply if the AC corresponding to the profit maximising output lies above the corresponding price. In this case however the short run problem for the monopolist becomes one of minimising the loss. However, a firm will go on operating in a monopoly market through the long run if only he earns positive profits. Such profits can be sustained in the long run since in spite of the supernormal profits that may act as incentives to new firms, the barriers to entry are assumed to be strong enough to prevent new entry in a monopoly market structure. In the long run, the equilibrium condition is LMC = MR with the MR curve being intersected from below by the LMC curve. However the monopolist is limited in hiking the pricing over a certain extent as the negative income effect it generates may cause consumers to move on to substitute goods and thus causing a loss in revenue. However as long as the monopolist produces the profit maximising output and charges the corresponding optimal price, he/she shall be earning supernormal profits in the long run as well. 5. What is an oligopoly? Explain the difference between natural and strategic entry barriers to entry in oligopoly. What are the implications of this for competition policy? Oligopoly is a type of market organization in which there are a few sellers as a result of which the actions of each individual seller affects the others. So there is a structural strategic interdependence within firms in an oligopoly market. Oligopoly markets observe strong entry barriers that keep the number of firms in the market down to a few. These barriers can be of two main types – structural and strategic. Structural entry barriers are exogenous in nature. That is to say, these have more to do with the basic structure of the industry in question. Structural aspects such as cost and demand conditions posing problems for new entrants are essentially what we call structural barriers. These have nothing to do with the tactical actions of the incumbents in the market. These can often be quantified. For instance the amount of investment required for building a plant that will be efficient, or the costs that have to be incurred for inputs are generally known. Cultural differences, geographical isolation, government regulations and insufficient market size are examples of structural barriers. Strategic barriers on the other hand refer to those endogenous deterrents put up by the incumbents of any market to prevent further entry. Sometimes certain structural barriers are enhanced by the actions of the pre-existing firms and thus serve as strategic barriers. These can arise out of actions like exclusive dealing arrangements by the incumbents. Due to the nature of these barriers it is far more difficult to measure the exact extent they serve in deterring new entrants. Such tactical barriers can be put up by the incumbents through actions like acquisition or mergers, product differentiation, vertical integration, capacity expansion and predatory pricing. So, the essential difference between structural and strategic barriers is that while the former is present due to structural factors that are exogenous to the actions of the incumbents themselves, strategic barriers are exogenously set up by the incumbent firms through their tactical actions. Barriers to entry have important bearing on competitive policy because assessment of aspects like dominance, determination of the strength of unilateral or multilateral conduct that may deter entry of new firms and analysis of the likely competitive effects of mergers all have crucially important roles for competitive policy. For instance, if it is known that a merger will significantly reduce the degree of competition in a market, the possibility of new firms entering easily and quickly somewhat counteract the anti-competitive effects of the merger itself. 6. Why might firms want to grow? Explain how horizontal, vertical and diversified growth can help firms to grow. Firms are motivated to grow primarily due to the following benefits that are associated with growth. Cost Savings: The process of internal or external growth both have associated cost saving benefits. Internal growth is often associated with the benefits of economies of scale. Again, external growth through acquisitions or mergers may often have their own cost saving benefits. For example acquiring an under performing or new firm may represent a more cost effective method of growth rather than internally creating equivalent capacity. Control of Markets: Larger firms are more likely to have more influential effects on the market through better control on the aggregate industry supply as well as better access to outlets. Managerial Rewards: Managerial motives like attaining power, influence, status etc may often motivate external growth. Shareholder Value: Growth in firms either external or internal increase the value of the over all business for the shareholders thus motivating further investment. Asset Stripping: A larger business concern shall have better asset stripping options. Efficiency: Growth is also associated with improved options of increasing technical, productive and allocative efficiency. Synergy: The essence of synergy is the notion that the whole is more efficient than the sum of the parts. This is also an important motivation for external growth. Risk Bearing: Diversifying into multiple production houses can better nullify risks. External growth of firms can occur through Horizontal, Vertical or diversified growth or integration. Horizontal growth refers to the process of external growth through amalgamation, merger or takeover at the same stage of the productive process. Consider the following example of a confectionary manufacturer. This business is growing externally by integrating with a soft-drink manufacturer. Note that both these firms belong to the same stage of the productive process. However vertical integration refers to amalgamation, merger or takeover at different stages of the productive process. It may be such that a retail store belonging to the tertiary sector integrates with a certain manufacturer firm who belongs to the secondary sector. However this integration does make the firm externally grow. This is referred to as Vertical Integration Backwards as here the acquisition takes place towards the source. Diagram (a): Vertical integration backward. Or it may be the other way round where we have Vertical Integration Forwards. Consider the following example of a dairy farming co-operative deciding to grow by integrating with a a cheese plant processing unit. Here, the acquisition takes place towards the market (See diagram below) Diagram (b): Vertical Integration Forwards Diversified growth occurs through amalgamation, merger or takeover of firms in different lines of business. For example if a global software giant decided to integrate with a sports magazine. 7. What is the ‘principal-agent’ problem? Analyse how it relates to the management of a business? The principal-agent problem arises when an agent is hired by a party (the principal) to act on its behalf but due to incomplete or imperfect or asymmetric information can not observe the type (if he is hard working or lazy for instance) or the actions (i.e if he is fulfilling his contracted duty or not) of the agent either or both of which influence the returns for the hiring party from the enactment of the contract. P = Principal, A = Agent So in essence, the problem of motivating one party to act on behalf of another is known as ‘the principal-agent problem’. When a principal compensates an agent for performing certain acts that are useful to the principal and costly to the agent, and where there are elements of the agent’s performance that are costly to observe due to informational incompleteness or imperfections, we have a principal-agent problem. In the real world characterized by information asymmetry, uncertainty and risk, the principal agent problem is holds true to some extent for all contracts that are written as principals do not know enough about whether or rather to what extent a contract has been satisfied by the hired agent. Evidently thus, this problem is very relevant to management of any business where hiring the right type of personnel and extraction of efficient performance form them have crucial roles to play for its success. In fact in all types of contracts that effectively managing a business entails is associated to some extent to this problem. Apart from contracting personnel a good example of the principal-agent relationship as it exists would be the relationship between the shareholders and the board of directors of a business concern. Shareholders act as principals, and the board as agents – principals expect agents to act in their interest. Sub-contracting work, which is an important and integral part of any business, also operates on a similar basis. 8. What is meant by globalisation? Who benefits from it? Globalization refers to the process of international integration. It is essentially the on going process through which the people of the world are being unified into a single society. It is a composite of economic, technological political as well as socio-cultural forces that is motivating this process. In terms of economics, the process of integration of all the markets over the world is referred to as globalisation. Globalization therefore is a process that opens up the international markets for all economies that decide to participate in international markets. From the perspective of a free market economy, globalization therefore implies increased potential markets for its entrepreneurs on one hand and better access to competitive resources and raw materials on the other. This dual benefit therefore implies that business concerns shall definitely benefit from the process. However, it should also be noted that for weaker and inefficient firms that had survived due to the erstwhile isolation will be exposed to great competition and are likely to be shaken of. But at the same time, this increase in competition will imply global firms trying to one up the other though constant competition which is likely to improve the standards of the products as well as increase their accessibility through lowered prices. So, this increased competition should be healthy from the perspective of consumers who shall now have access to better alternatives at lower prices. Also the possibility of firms becoming more efficient to remain in the race is there. So, all in all, globalization benefits all types of buyers, be they so in final goods markets or in markets for intermediaries. Globalization also opens up the possibility of FDI inflows which have their own associated benefits. Therefore the countries that enjoy FDI inflows also add to the list of beneficiaries of globalization. 9. What is FDI? Why has it increased in the world and how might it affect the UK? Foreign direct investment (FDI) is defined by the UNCTAD as investment that is made to acquire lasting interest in enterprises operating outside of the economy of the investor. The FDI relationship is built on a parent enterprise and a foreign affiliate which together form a trans-national corporation (TNC). However, to qualify as FDI the investment must be able to afford control for the parent enterprise over its foreign affiliate. Control in this respect is generally understood as owning at least 10% of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm. Investment that acquires ownership rights is known as portfolio investment. Since the advent of globalization as more and more countries started to open up their domestic markets to foreign investments, FDIs started to rise. Since often countries that invite FDI suffer from the lack of investible funds, these days there is considerable competition among economies suffering from investment deficiencies to attract funds. This has led them to try and build up better infrastructures and make conditions lucrative for foreign investors. Hence, since the advent of globalization there has been an upsurge in FDI flows all over the world. Firms can now take new products and processes to markets that they would not have otherwise penetrated. This raises the income of both home and host. As markets are getting integrated increased economic activity is creating investment vacuums which are being targeted by many large global players in the financial market. Often they are tying in other business houses to reduce the risks and this is also evident in recent figures that show large surges in FDI. In this era, multinational enterprises have a significant impact on the employment and output distribution across Europe. European integration is causing the nature of production to evolve. Reduction of barriers to trade and enhanced capital mobility is making firm relocation to be easier. And their foreign investment can have a considerable impact on the potential growth rate of host economies and the level of employment they can sustain. UK is thus likely to have multiple benefits from these FDI inflows. First of all, an overall productivity surge can be expected as the existing resources shall have more capital to work with. Secondly, in recent times, UK trade balance has been suffering from reduced exports in the last ten years due to the large outward investment it participates in. Inflows of capital certainly shall reduce this pressure. Finally the very flexible labour market combined with these FDI inflows can lead to significant growth. Thus, the FDI inflows are likely to generate quite a few large number of benefits for the economy as a whole. Read More