lecture8 organisation of production wk8
TRANSCRIPT
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ORGANISATION OF PRODUCTION
UG Business Economics
Lecture 8
Abhijit Sharma
MAN0101M
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UG Business Economics: Lecture 8 1
Learning outcomes
After the lecture you should understand:
Efficiency drives changes in the boundaries offirms
Definitions of horizontal, vertical, and diversifiedgrowth
The differences between horizontal, vertical anddiversified growth
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UG Business Economics: Lecture 8 2
Black box economics
Goods
and
Services
Labour
Land
Capital
Enterprise
The Firm
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UG Business Economics: Lecture 8 3
Firms are profit maximisers
Firms organize production so that
MPL MPK PL PK
Firms can experience economies of scale
Switching on the light?
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UG Business Economics: Lecture 8 4
How do firms organize production?
Why are some intermediate goods made internally,whilst others are purchased externally?
Why are workers paid a salary, not commission?
Who decides the firms objectives?
Why do firms exist?
The need for more light
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UG Business Economics: Lecture 8 5
Growth strategies
Horizontal growth occurs at the same stage ofproduction
Vertical growth occurs along the value chain(upstream or downstream)
Diversifiedgrowth occurs when a firm moves into anunrelated market
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UG Business Economics: Lecture 8 6
Means of growth
Organic firms growing through internal expansion
Merger two firms agreeing by mutual consent tomerge their existing operations
Acquisition one firm purchasing another firm eitherthrough a hostile take over or through mutual consent
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UG Business Economics: Lecture 8 7
Benefits of horizontal growth (I)
Revenue advantages through:
Reduced competition Merger or acquisition reduce competition, fall in
price elasticity, making price rises easier
Market growth Organic, merger or acquisition enable a firm to
exploit customer growth opportunities
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UG Business Economics: Lecture 8 8
Benefits of horizontal growth (II)
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AC LRAC
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3AC1
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UG Business Economics: Lecture 8 9
Cost reductions through:
Economies of scale
Rationalisation of the business
Learning curve effects with cumulative output
Benefits of horizontal growth (III)
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UG Business Economics: Lecture 8 10
Boundaries of the firm - vertical growth
Production
Suppliers
Retailers
Production Production
Suppliers Suppliers
RetailersRetailers
Production
Suppliers
Retailers
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UG Business Economics: Lecture 8 11
Reasons for vertical growth
Reduces production costs through location benefits
Technological interdependence
Avoids problems from monopoly control of a productionor distribution stage
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UG Business Economics: Lecture 8 12
The missing cost
COST OF PRODUCTION
Labour Land Capital
Enterprise
COSTS OF ORGANISING
Writing contracts Dealing with complexity
Minimizing shirking Avoiding adverse selection
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UG Business Economics: Lecture 8 13
Transaction costs (I)
Contracts
Complexity
Output
Low
Complete
Objective
High
Incomplete
Subjective
MARKET TRANSACTION
Lowcost Highcost
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UG Business Economics: Lecture 8 14
Transaction costs (II)
Transaction costs increase with:
Complexity
Uncertainty
Monitoring
Enforcement
Reduction of transaction costs through make or buy
High transaction costs associated with buying the
good or service through the market, then makethe good or service internally
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UG Business Economics: Lecture 8 15
REASONS
Activities can be undertaken at lower cost outside the
firm than within
Stemming from a reduction in market transaction
costs
EXAMPLES
Hospitals outsource laundry and catering services
McDonalds restaurant franchising
Insurance companies using external sales forces
Vertical disintegration
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UG Business Economics: Lecture 8 16
Conglomerate integration - diversified growth
Diversification involves a company to expand itsoperations into related or unrelated markets
Benefits of economies of scope - synergies
Cost (A) + Cost (B) > Cost (A+B)
Diversification and risk reduction
Diversified portfolio of activities Uncorrelated business activities
Off-setting income streams
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UG Business Economics: Lecture 8 17
Key learning points
You have been introduced to:
Efficiency drives changes in the boundaries offirms
Definitions of horizontal, vertical, and diversifiedgrowth
The difference between horizontal, vertical anddiversified growth