Docstoc

01 Factors Affecting the Firm

Document Sample
01 Factors Affecting the Firm Powered By Docstoc
					1

STUDY UNIT ONE FACTORS AFFECTING THE FIRM

1.1
1.2

Demand
Supply

...............................................................
.................................................................

2
7

1.3
1.4 1.5 1.6

Market Equilibrium and Pricing
Externalities Antitrust Law Core Concepts

..............................................

10
12 13 16

............................................................ ............................................................ ..........................................................

This study unit is the first of five on business economics. The relative weight assigned to this major topic in Part 1 of the exam is 25% at skill level B (four skill types required). The five study units are Study Unit 1: Factors Affecting the Firm Study Unit 2: Consumption and Production Study Unit 3: Market Structures Study Unit 4: Macroeconomic Issues, Measures, and Cycles Study Unit 5: Government Participation in the Economy Economics is the social science addressing the allocation of scarce resources among competing uses. Individuals face an economic problem when deciding how to spend limited income to maximize satisfaction, and the nation faces an economic problem in deciding how to allocate fixed resources (land, labor, capital, and entrepreneurial ability) to achieve maximum social welfare. Economics is based on the law of scarcity. Human wants are unlimited, but the resources available to satisfy those wants are limited. Accordingly, every economic system (capitalistic, socialistic, etc.) must determine what goods and services should be produced, the amounts to be produced, and how and for whom they should be produced. The study of economic issues traditionally has two perspectives: micro and macro. Microeconomics is the study of the individual economic units in the economy. It is covered in the first three study units. The focus is on the consumer (as buyer of finished goods and seller of labor, entrepreneurial services, and capital) and the firm (as seller of finished goods and buyer of labor, entrepreneurial services, and capital). Macroeconomics is the study of economic aggregates and an overview of the economy, including levels of national income, employment, and prices and the effects of monetary and fiscal policies. Macroeconomics is covered in Study Unit 4 and Study Unit 5. After studying the outlines and answering the multiple-choice questions, you will have the skills necessary to address the following topics listed in the IMA’s Learning Outcome Statements: Part 1 – Section A.1. Factors affecting the individual firm The candidate should be able to: a. b. c. d. e. f. g. demonstrate an understanding of the laws of supply and demand interpret a graph of supply and demand demonstrate an understanding of how prices are determined by the interaction of supply and demand differentiate between changes in demand and changes in the quantity demanded differentiate between changes in supply and changes in the quantity supplied identify the market equilibrium price demonstrate an understanding of how surpluses and shortages affect the market price
Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

2

SU 1: Factors Affecting the Firm

h. i. j. k. l. m. n.

o.

p. q. r. s.

calculate the price elasticity of demand define elastic and inelastic demand and identify each on a graph estimate total revenue given changes in prices and demand as well as elasticity coefficients calculate the price elasticity of supply calculate the cross elasticity of demand and the income elasticity of demand define externalities apply the law of supply and demand and the concepts of elasticity of supply and demand to government intervention in the market; such as price supports, minimum wages, rent control, mandated regulation, etc. identify and recognize the major provisions of U.S. Federal antitrust legislation, including the Sherman Act, the Clayton Act, the Robinson-Patman Act, the Federal Trade Commission Act, and other relevant legislation list the objectives of antitrust legislation identify antitrust enforcement sanctions available to the Federal government demonstrate an understanding of the economic impact of antitrust regulation demonstrate an understanding of governmental regulation of natural monopolies

1.1 DEMAND 1. Demand -- the Buyer’s Side of the Market a. Demand is a schedule of the amounts of a good or service that consumers are willing and able to purchase at various prices during a period of time. Quantity demanded is the amount that will be purchased at a given price during a period of time. A demand schedule can be graphically depicted as a relationship between the prices of a commodity (on the vertical axis) and the quantity demanded at the various prices (horizontal axis), holding other determinants of demand constant. 1) The Law of Demand. If all other factors are held constant (ceteris paribus), the
price of a product and the quantity demanded are inversely (negatively) related;

b.

i.e., the higher the price, the lower the quantity demanded.

c.

The determinants of demand are any factors other than price that affect the amount of a commodity that consumers purchase. 1) Consumer incomes Most goods are normal goods, that is, commodities for which demand is positively (directly) related to income, e.g., steak, new clothes, and airline travel. b) However, a few goods are inferior goods, that is, commodities for which demand is negatively (inversely) related to income, e.g., potatoes, used clothing, and bus transportation. Consumer taste and preference a)

2)

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

3

3)

Prices of related goods Substitutes. If products A and B are substitutes, a price increase in A will generate an increase in the demand for B. For example, when beef prices rise, the demand for chicken increases. b) Complements. If products A and B are complements, a price increase in A will generate a decrease in the demand for B. For example, if the price of bread increases, the demand for jelly decreases. c) See cross-elasticity of demand under item 2.c.. Consumer expectations a)

4)

d.

a) Do consumers expect incomes and prices to rise or fall? 5) Number of consumers A change in price results in a change in quantity demanded, i.e., movement along a demand curve (depicted in the graph on the previous page). 1) A change in any factor other than price results in a change in demand, i.e., a shift of the curve itself.

2)

An increase in demand for a product like that depicted in the graph above (a shift in the demand curve outward or to the right) can be caused by a) b) c) d) e) f) g) A favorable change in the tastes and preferences of consumers toward the product An increase in consumer incomes, if the product is a normal good A decrease in consumer incomes, if the product is an inferior good An increase in the price of a substitute A decrease in the price of a complement The expectation of future price increases The end of a group boycott

3) 2. Elasticity
a.

A decrease in demand for a product (a shift in the demand curve inward or to the left) can be caused by the opposite of the factors listed above.

Elasticity is the ratio of the percentage change of a result for each percentage change

b.

in the cause. Price elasticity of demand (Ed) is the percentage change in quantity demanded divided by the percentage change in price. It measures the responsiveness of a change in quantity demanded to a change in the price of a product. 1) 2) For a demand schedule obeying the law of demand (downward sloping), the elasticity coefficient (E) is negative. However, when interpreting Ed, the absolute value is ordinarily used.

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

4

SU 1: Factors Affecting the Firm

3)

Factors affecting the price elasticity of demand are Classification of the good as a luxury (more elastic) or a necessity Percentage of income spent on the goods (the higher the percentage, the more elastic) c) Availability of substitutes (the more substitutes there are for a good, the more elastic) d) Passage of time (the longer the time period analyzed, the more elastic) When the demand elasticity coefficient is a) b) Greater than one, demand is in an elastic range. A small change in price results in a large change in quantity demanded. Equal to one, demand has unitary elasticity (usually a very limited range). A single-unit change in price brings about a single-unit change in quantity demanded. Less than one, demand is in an inelastic range. A large change in price results in a small change in quantity demanded. Infinite, demand is perfectly elastic (depicted as a horizontal line). In pure competition, the number of firms is so great that one firm cannot influence the market price. The demand curve faced by a single seller in such a market is perfectly elastic (although the demand curve for the market as a whole has the normal downward slope). ii) EXAMPLE: Consumers will buy a farmer’s total output of soybeans at the market price but will buy none at a slightly higher price. Moreover, the farmer cannot sell below the market price without incurring losses. Equal to zero, demand is perfectly inelastic (depicted as a vertical line). i) i) a) b)

4)

c) d)

e)

5)

Some consumers’ need for a certain product is so high that they will pay whatever price the market sets. The number of these consumers is limited and the amount they desire is relatively fixed. ii) EXAMPLE: Addiction to illegal drugs tends to result in demand that is unresponsive to price changes. In this example, existing buyers (addicts) will not be driven out of the market by a rise in price, and no new buyers will be induced to enter the market by a reduction in price. The effect of price changes on total revenue (TR) is a straightforward means of determining whether demand is elastic. TR equals price times quantity. The effects of price changes on TR are summarized in the following table: Elastic (E > 1) TR down TR up Inelastic (E < 1) TR up TR down Unitary Elasticity (E = 1) TR same TR same

Price up Price down 6)

According to the arc method of calculating the price elasticity of demand, the numerator and denominator are stated as the change over the average. The result is the same percentage regardless of whether an increase or a decrease has occurred.

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

5

a)

Roxy’s Ice Cream Shoppe sells 100 quarts of chocolate a day at $6 each.

If it charges $3 per quart, it will sell 300 quarts a day. According to the arc formula,

7)

Given a coefficient of 1.5, demand is elastic, and total revenue increases when the price is lowered. The slope of the demand curve does not always indicate its elasticity. A demand curve is usually elastic in its upper range and inelastic in its lower range. a) EXAMPLE: As depicted in the graph of the demand curve AB below, a reduction in price from $10 to $9 results in a price elasticity greater than 1, but a reduction from $2 to $1 results in a price elasticity less than 1.

i)

8)

9)

Cost increases. Increases in costs of wages, taxes, materials, etc., are most easily passed on to buyers when demand is inelastic. a) For example, minimum wage laws are most likely to have their desired effect when the demand for low-wage workers is inelastic. In that case, the income lost from the decline in employment resulting from the higher minimum wage may be more than offset by the income gained by workers who retained their jobs. Although the arc method of calculating elasticity is perhaps the best, some economics textbooks show another method, which we call the “simple” method. The general formula is the same (percentage change in quantity demanded ÷ percentage change in price), but the change in the numerator and denominator is divided by the previous quantity and price, respectively (instead of the average).
a) For example, based on the numbers in the previous example for Roxy’s Ice

Cream Shoppe, the calculation is

b)

Given that the coefficient is 4.0 (or greater than 1.0), demand is elastic, and total revenue will increase.

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

6

SU 1: Factors Affecting the Firm

c.

The coefficient of elasticity under the simple method (4.0) is far different from the coefficient under the arc method, but the important consideration is how the coefficient compares with unitary elasticity, or 1.0. If the coefficient, however calculated, is greater than 1.0, the product has an elastic demand. If elasticity is less than 1.0, demand is inelastic. d) The CMA exam has rarely asked for an actual calculation, but it is possible that either method may be tested. More important, however, is knowing the meaning of the answers. The cross-elasticity of demand measures the percentage change in demand for one good given a percentage change in the price of another good. 1) Cross-elasticity of demand mathematically depicts the substitution effect. When a price decreases, new buyers will enter the market. The good will be cheaper relative to other goods and is substituted for them. The cross-elasticity coefficient (Exy) is found by using the following equation:

c)

2)

3)

If the coefficient is Positive, the two goods are substitutes [see the example in c.4)]. Substitutability is directly correlated with the magnitude of the positive coefficient. b) Negative, the two goods are complements. Complementarity is directly correlated with the magnitude of the negative coefficient. c) Zero, or near zero, the two goods are unrelated. EXAMPLE: The price of orange soda increases 20%, and the demand for root beer increases 10%. Accordingly, orange soda and root beer are substitutes. a)

4)

d.

Cross-elasticity of demand can be used to define a market and to determine an appropriate marketing strategy. In addition, the information can be used to determine what and how much to produce. Income elasticity of demand measures the percentage change in quantity demanded given a percentage change in income. 1) Income elasticity of demand mathematically depicts the income effect. When a price decreases, individuals have more buying power and will buy more of the product. The income elasticity (EI) is found using the following equation:

5)

2)

3)

If the coefficient is a) b) Greater than zero, the good is considered a normal good. If income rises, consumption of the good rises. Less than zero, the good is considered an inferior good. If income rises, consumption of the good decreases.

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

7

4)

EXAMPLE: Income increases by 20%, and the demand for diamonds increases by 15%. Diamonds are normal goods. As people earn more, they purchase more diamonds.

1.2 SUPPLY 1. Supply -- the Seller’s Side of the Market a. Supply is a schedule of the amounts of a good that producers are willing and able to offer to the market at various prices during a specified period of time. Quantity supplied is the amount that will be offered at a given price during a period of time.
A supply schedule can be graphically depicted as a relationship between the prices

b.

of a commodity (on the vertical axis) and the quantity offered at the various prices (horizontal axis), holding other determinants of supply constant. 1) The Law of Supply. If all other factors are held constant (ceteris paribus), the price of a product and the quantity supplied are directly (positively) related; i.e., the higher the price, the greater the quantity supplied.

c.

The determinants of supply are any factors other than price that affect the amount of a commodity that producers offer. 1) 2) 3) 4) 5) Production prices Technology Prices of other goods Price expectations Taxes and subsidies

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

8

SU 1: Factors Affecting the Firm

d.

A change in price results in a change in quantity supplied, i.e., movement along a supply curve (depicted in the graph on the previous page). 1) A change in any factor other than price results in a change in supply, i.e., a shift of the curve itself.

2)

An increase in supply for a product like that depicted in the graph above (a shift in the supply curve outward or to the right) can be caused by a) b) c)

e.

A decrease in a factor of the production price An improvement in technology A decrease in the demand for another product, inducing firms to divert resources away from the production of that product d) The expectation of future price decreases e) A decrease in taxation of a good or an increase in subsidization f) A decrease in unit production costs as a result of decreased government regulation 3) A decrease in supply for a product (a shift in the demand curve inward or to the left) can be caused by the opposite of the factors listed above. Economic Rent. If the price paid for any input is higher than would have been paid by the next highest bidder for that input, economic rent is said to be earned. 1) When economic rent is earned, the supplier of an input is being paid more than is necessary to keep the input employed in production. For example, a $5,000,000-a-year baseball player is earning economic rent of $4,950,000 if the player could earn only $50,000 per year in another occupation. But if the supply of a resource is fixed (e.g., land), the entire price paid is deemed to be a surplus (economic rent) because a change in price will not affect total supply (the productive potential of the economy). a)

2)

2.

Elasticity a. Price elasticity of supply (Es) is the percentage change in quantity supplied divided by the percentage change in price. It measures the responsiveness of a change in quantity supplied to a change in the price of a product. 1) 2) The same formulas used in the calculation of price elasticity of demand (the arc method and the “simple” method) are used to calculate the price elasticity of supply (see item 2. under subunit 1.1).

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

9

3)

Factors affecting the price elasticity of supply are a) Cost and feasibility of storage EXAMPLE: A high cost of storage results in low elasticity because, as the price of carrying a good increases, the tendency to hold that good decreases. Characteristics of the production process i) c) Time i) EXAMPLE: The price elasticity of supply of a joint product may be affected by the demand for the other joint products. i)

b)

4)

EXAMPLE: Production of goods, i.e., the ability to supply them, becomes more elastic with time. When the supply elasticity coefficient is a) b) Greater than one, supply is in an elastic range. A small change in price results in a large change in quantity supplied. Equal to one, supply has unitary elasticity (usually a very limited range). A single-unit change in price brings about a single-unit change in quantity supplied. Less than one, supply is in an inelastic range. A large change in price results in a small change in quantity supplied. Infinite, supply is perfectly elastic (depicted as a horizontal line). A perfectly elastic supply curve exists only in theory. The costs of inputs and fixed investments in property, plant, and equipment prevent a supplier from charging a single price for the whole range of possible quantities. Equal to zero, supply is perfectly inelastic (depicted as a vertical line).
i) A perfectly inelastic supply curve indicates that, in the very short run,

c) d)

i)

e)

b.

c.

a seller cannot change the quantity supplied. EXAMPLE: A farmer offering a perishable good with no means of storage must sell the entire crop regardless of the price buyers offer. The farmer cannot offer a larger quantity because the harvest has ended for the season. Over time, the supply curve becomes more elastic for a firm with a fixed investment in plant. To justify a cost increase (which would necessarily result in a price increase), the firm must be presented with an upward sloping supply curve. Price and total revenue always move in the same direction regardless of the price elasticity of supply. ii)

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

10

SU 1: Factors Affecting the Firm

1.3 MARKET EQUILIBRIUM AND PRICING 1. The market is the interaction of buyers and sellers brought into contact with one another to engage in purchases and sales of economic goods. a. Economic goods are goods that are scarce. They are demanded, but their supply is insufficient to meet all demand. Equilibrium between price and output is the point where the demand and supply curves intersect. The graph illustrates the concept of market equilibrium, i.e., the intersection of the supply and demand curves.

2.

a.

At the point of intersection of the supply and demand curves, anyone wishing to purchase economic goods at the market price can do so. The market forces of supply and demand thus create an automatic, efficient rationing system. 1)

3.

When a shortage exists, the quantity demanded exceeds the quantity supplied at the current price. The price will rise, new suppliers will be induced to enter the market, and the shortage will be eliminated. 2) When a surplus exists, the quantity supplied exceeds the quantity demanded at the current price. The price will fall, suppliers will exit the market, and the surplus will be eliminated. The Effects on Equilibrium of Shifts in the Supply and Demand Schedules a. b. c. d. e. An increase in supply (with demand held constant) will decrease the equilibrium price and increase the equilibrium quantity. A decrease in supply (with demand held constant) will increase the equilibrium price and decrease the equilibrium quantity. An increase in demand (with supply held constant) will increase the equilibrium price and quantity. A decrease in demand (with supply held constant) will decrease the equilibrium price and quantity. Simultaneous shifts in supply and demand and their resulting effects on equilibrium can be summed up as follows: 1) An increase (decrease) in demand and supply will cause the equilibrium quantity to increase (decrease), but the effect on the equilibrium price is indeterminable. 2) An increase (decrease) in demand and a decrease (increase) in supply will cause the equilibrium price to increase (decrease), but the effect on the equilibrium quantity is indeterminable.

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

11

4.

Price control is the setting of mandatory or artificial prices. It often interferes with the free operation of the market. Attempts to alter output and price can affect equilibrium. a. Price ceiling. Price is established below the equilibrium price, causing shortages. The usual result is nonprice competition among buyers (waiting lines are one form), which allocates the quantity that is supplied. 1) Rent control is an example. Under rent control, prices (to the renter) are set below their true equilibrium level. Because of this policy, fewer apartment owners are likely or willing to maintain (or increase) their stock of real estate, resulting in under-investment in the housing sector. The graph below depicts a shortage resulting from an artificially low price.

2)

b.

Price floor. A minimum price is set above the equilibrium price, causing surpluses to develop. 1) Price supports for agricultural products are an example. These price floors result in surpluses that the government must buy. The effects are (a) revenue gains for farmers, (b) higher prices paid and lower amounts purchased by consumers, (c) higher taxes to finance price support programs and provide for storage of surpluses, (d) overallocation of resources to U.S. agriculture, and (e) less efficient use of international agricultural resources because of import barriers to protect subsidized domestic producers. Minimum wage legislation is another well-known example of a price floor. See item 2.b.8) under subunit 1.1. The graph below illustrates a surplus because of an artificially high price. a)

2)

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

12

SU 1: Factors Affecting the Firm

5.

Taxes are another form of regulation affecting cost, price, and output. a. A license fee is a lump-sum tax that must be paid if a firm is to operate. Short-run effect. The tax raises average cost but does not change marginal cost. Thus, the firm’s output decision remains unchanged. 2) Long-run effect. In a competitive industry, firms are not making profits after the tax. Some firms leave the industry. The industry price is higher, and total industry output is lower. Profits tax. This tax does not change the firm’s revenue or cost functions. This implies that the output to maximize pretax profits also maximizes after-tax profits. Hence, a firm’s optimal output is unchanged. Per-unit tax. This tax, e.g., sales, excise, and value-added taxes, creates a difference between demand price (what consumers are willing to pay) and the price a firm receives. 1) The effect is to decrease marginal revenue. The firm’s response is to lower the quantity produced by moving down the marginal cost curve. Governmental action is sometimes anticompetitive. Examples are 1) 2) Patent, copyright, trademark, and trade name protection Price supports (see 4.b. on the previous page), such as for certain agricultural commodities, or price ceilings (see 4.a. on the previous page), e.g., on utility rates Licensing of television and radio stations Tariffs, import quotas, and other restrictions on foreign producers’ access to domestic markets Costs driven up by governmental regulation Larger, more established companies benefiting by governmental spending 1)

b.

c.

d.

3) 4) 5) 6) 1.4 EXTERNALITIES 1.

Externalities, or spillover effects, are benefits or costs affecting third parties. For example, transactions between a firm and its customers (or between a government and some of its citizens) may have external costs or benefits. These costs or benefits are not fully reflected in the supply and demand curves. a. Thus, they represent a market failure to allocate resources efficiently because the price is not based on all relevant economic information. b. A classic private-sector spillover cost is pollution. For example, pollution of Lake Michigan by an automobile manufacturer that does not clean it up results in lower costs than if the company used pollution equipment or other purification methods. It also results in a lower price and greater output. Because the cars are relatively cheaper, more people buy them, encouraging still more pollution. The result is too many cars produced at too low cost with too much pollution. 1) Government can intervene to eliminate these spillover costs by compelling the polluter to bear all of the costs of production, e.g., by enacting and enforcing environmental laws or imposing specific taxes. c. Spillover benefits also may arise. Typical examples are public goods. 1) Government provides public goods and quasi-public goods, such as education, national defense, highways, and environmental protection. People who do not contribute to their costs are not excluded from their benefits.

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

13

1.5 ANTITRUST LAW 1. Part 1 of the examination tests the candidate’s knowledge of major federal legislation that regulates businesses and the effects of that legislation on business. The effect of regulation on firms, e.g., on costs and prices, and the rationale for regulation are based on microeconomic theory. Competition is used to control private economic power. Accordingly, the objective of antitrust law is to take actions that promote competition and a. Efficient allocation of resources (resulting in lower prices) b. Greater choice by consumers c. Greater business opportunities d. Fairness in economic behavior e. Avoidance of concentrated political power resulting from economic power Sherman Act of 1890 a. Section 1 makes illegal every contract, combination, or conspiracy in restraint of trade in interstate or foreign commerce. 1) The commerce clause of the U.S. Constitution (Article I, Section B, Clause 3) has been the basis for a considerable extension of federal power in the regulatory sphere because most businesses affect interstate commerce. The rule of reason is applied so that only unreasonable restraints are illegal. EXAMPLE: A covenant not to compete is enforceable as long as it is for a reasonable time and a reasonable area. Some types of arrangements between competitors are found unreasonable without inquiry. They are called per se violations. These include a) b) c) d) a)

2.

3.

2)

3)

b.

Price-fixing (agreeing to any price) Division of markets (agreeing where to sell) Group boycotts (agreeing not to deal with another) Resale price maintenance (limiting a buyer’s resale price) i) These arrangements limit competition at the expense of the consumer. 4) Price fixing is the most prosecuted violation under the Sherman Act. Section 2 prohibits the acts of monopolizing or attempting to monopolize. 1) 2) Monopoly is the power to control prices or exclude competition. The government must prove overwhelming market power and that the act of monopolizing, attempting to monopolize, or conspiring or combining to monopolize is a deliberate or purposeful act. a)

4.

Acquisition of power through superior skill or having it thrust upon one is not a violation. The Clayton Act of 1914 prohibits a. Mergers or the acquisition of stock if the effect may be to lessen competition or tend to create a monopoly. The act allows the Justice Department to prevent mergers before they occur. 1) A horizontal merger (between competitors) is most closely scrutinized by the Justice Department because it usually has the greatest tendency to lessen competition. A vertical merger (between supplier and purchaser) may also lessen competition if each controls a substantial part of the relevant market.

2)

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

14

SU 1: Factors Affecting the Firm

5.

A conglomerate merger involves different industries or different areas of business. It is the least likely to lessen competition unless the resulting company is so large that its size alone affects competition. b. Sales that prevent the buyer from dealing with the seller’s competitors. c. Tying or tie-in sales, that is, sales in which a buyer must take other products in order to buy the first product. d. Exclusive dealing, which occurs when a seller requires a buyer to purchase only the seller’s products and not buy any products from the seller’s competitors. e. Price discrimination between different buyers. f. A person from sitting as a director of competing corporations (interlocking directorates) if one company has capital of greater than $1,000,000 and if antitrust law would be violated if the companies ceased to be competitors. Federal Trade Commission Act of 1914 a. b. The act prohibits unfair methods of competition and unfair or deceptive acts in commerce. It created the Federal Trade Commission (FTC) to enforce this act and determine what is unfair competition or deceptive acts. 1)

3)

6.

The basic objectives of the FTC are to initiate antitrust actions and to protect the consumer public. 2) The FTC also has broad authority to enforce the other antitrust laws in conjunction with the antitrust division of the U.S. Justice Department. 3) The Wheeler-Lea Amendment of 1938 prohibits deceptive practices in commerce. The Robinson-Patman Act of 1936 amended the Clayton Act with respect to price discrimination. a. b. c. d. Price discrimination is prohibited with respect to both buyers and sellers. 1) Both buyer and seller can be found guilty if there is discrimination. Price differentiation is allowed if it is to meet a competitor’s price or if it is based on quantity purchased and a cost savings can be shown. Rebates, commissions, discounts, etc., to special customers are prohibited. The act does not apply to export sales.

7.

The Celler-Kefauver Act of 1950 amended the Clayton Act to prohibit the acquisition of assets of another corporation if the effect could lessen competition or tend to create a monopoly. a. The Clayton Act originally applied only to stock acquisitions. The Antitrust Improvements Act of 1976 requires that notification be made to the Justice Department prior to a merger. Remedies for Antitrust Violations a. b. c. d. a. b. Court injunctions, forced divisions, and forced divestitures may be obtained by either the public or the government. Cease and desist orders may be issued by the FTC. Treble (triple) damages may be recovered by the public. Criminal penalties may be assessed by the government. Intrastate commerce Labor unions (not exempt if the union primarily intends to restrain trade or conspires with nonlabor groups to monopolize)

8. 9.

10. Exemptions from Antitrust Regulation

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

15

c. d.

Regulated utilities Reasonable noncompetition clauses between 1) Buyers and sellers of businesses 2) Partners in a partnership 3) Purchasers of technology or equipment Patents and copyrights
1) A patent is a grant made by a government to an inventor. This grant provides

e.

the inventor with monopoly rights to manufacture the invention. Under current U.S. law, a utility patent lasts 20 years, and a design patent 14 years. 2) A copyright offers protection for original works of authorship. An author’s copyright is for the life of the author plus 70 years. A publisher’s patent is for 95 years from publication or 120 years from creation, whichever expires first. f. Agricultural and fishing organizations g. Financial institutions h. Transport industries i. Major league baseball j. Companies qualifying for certificates of antitrust immunity issued by the Commerce Department (after concurrence by the Justice Department) under the Export Trading Company Act 11. Government Regulation of Natural Monopolies a. A natural monopoly, such as a utility (gas, water, electricity, etc.), exists when economies of scale are so great in an industry that the lowest per-unit cost can be achieved only if one firm produces all of the output demanded. Accordingly, the usual approach of antitrust law -- fostering competition -- leads to higher costs in an industry that tends toward a natural monopoly. Competitors in such an industry may charge higher prices than a monopolist and will have an incentive to merge. An unregulated monopolist charges a higher price and sells a lower output. Thus, regulation tends to focus on price control (setting a price ceiling). For example, if price is set at long-term average total cost, revenues equal costs, and the monopolist earns only normal profits. The difficulties of regulation are the following: 1) If the long-term fair return is the regulated price, the firm’s managers have less reason to control costs. If costs are decreased (increased), the price will be decreased (increased) so that the regulated return will be achieved. The regulator may not have the information about costs and demand curves needed to establish a price. A regulated firm may exert political influence over regulators. If the socially optimal price is the regulated price (ceiling price = MC), efficient allocation of resources is achieved. (If price exceeds MC, output is too low.) However, the dilemma of regulation applies. If the price is set equal to MC, the monopolist most likely will incur losses. The government may then need to subsidize the entity. 1)

b.

c.

2) 3) 4)

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

16

SU 1: Factors Affecting the Firm

12. The Federal Trade Commission and the Justice Department’s merger guidelines are standards for determining when regulators will oppose mergers. a. The concentration ratio is the percentage of an industry’s output produced by its four largest firms. Statistical studies often rely on the concentration ratio as a measure of monopoly market power in an industry. One disadvantage of the concentration ratio is that it does not measure the allocation of market power when an industry consists of only a few firms. 1) The Herfindahl index addresses this issue. It equals the sum of the squared market shares of the firms in the industry. The larger the index, the greater the market power in the industry. b. The guidelines also consider such factors as 1) 2) 3) 4) Barriers to market entry, Economic efficiency, Financial position of the merger partners, and Nature and price of the product.

1.6 CORE CONCEPTS Demand
■

■

■

The law of demand states that, as the price of a good rises, less of that good will be demanded by buyers. Thus, the demand curve is downward sloping and a change in price is graphically depicted as a movement along the curve. A change in any factor other than price (e.g., population size, consumer tastes, the prices of substitutes, etc.) results in a change in demand, i.e., a shift of the entire curve rather than a movement along an existing curve. The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. It is a measure of how sensitive consumer willingness to buy a product is with regard to the price of that product. The law of supply states that, as the price of a good rises, more of that good will be supplied by sellers. Thus, the supply curve is upward sloping and a change in price is graphically depicted as a movement along the curve. A change in any factor other than price (e.g., the prices of inputs, the level of technology, etc.) results in a change in supply, i.e., a shift of the entire curve rather than a movement along an existing curve. The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. It is a measure of how sensitive supplier willingness to provide a product is with regard to the price of that product. Equilibrium occurs at the single price at which buyers are willing to purchase the whole quantity that sellers are supplying and sellers are willing to supply the whole quantity that buyers are demanding. Graphically, this is the point where the market demand and supply curves intersect. Interference in the workings of the market, such as price controls, can have unintended consequences. When a price ceiling is established, sellers are not willing to supply all that buyers are demanding, and shortages result. When a price floor is established, buyers are not willing to purchase all that sellers want to supply, and surpluses result.

Supply
■

■

■

Market Equilibrium and Pricing
■

■

■

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com

SU 1: Factors Affecting the Firm

17

Externalities
■ ■

■

Externalities, or spillover effects, are benefits or costs affecting third parties. A classic private-sector spillover cost is pollution. When heavy industry is able to dispose of its waste without treatment, consumers benefit from lower prices. However, those same consumers eventually bear the costs of that pollution in the form of a degraded environment. Spillover benefits also arise, often in the form of public goods. Government provides schools and highways, and those who do not contribute to their cost still benefit from their use. The Sherman Act of 1890 makes illegal every contract, combination, or conspiracy that unreasonably restrains trade. The Clayton Act of 1914 prohibits mergers or the acquisition of stock that may lessen competition or tend to create a monopoly.

Antitrust Law
■

■

Use Gleim’s CMA Test Prep for interactive testing with over 2,000 additional multiple-choice questions!

Copyright © 2006 Gleim Publications, Inc. and/or Gleim Internet, Inc. All rights reserved. Duplication prohibited. www.gleim.com


				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:77
posted:7/29/2009
language:English
pages:17