Firms' Decisions and Strategies Memory Pack II

Firm Strategies Notes

Contents Contents 1 Structure 2 Strategies 4 1. Product Differentiation 4 2. Mergers, Acquisitions and Collusion 9 3. Lowering Prices 13 4. Impact on Society 14 5. Cost Reducing Strategies 16 6. Third Degree Price Discrimination 18 7. Cognitive Biases 19 8. Other Strategies 22 1

Structure Guiding principle: Assume the breadth required is writing multiple strategies unless it contradicts what the question asks of you. Main Type 1: Discuss possible strategies a firm might employ when (cause) . Type 1a: Natural Causes – recession, increase in factor input prices, COVID-19, etc. ● State that firms are profit maximising ● B1: Explain how the cause impacts the market ● B2a: Strategy 1 → Working → Ev1: Limitations/Trade-offs ● B2b: Strategy 2 → Working → Ev2: Limitations/Trade-offs ● Evaluate which strategy is most effective/suitable given the context of the question Type 1b: Market Characteristics – changes in level of competition, type of product sold, etc. ● State that firms are profit maximising ● B1: Elaborate on the market’s characteristics and how the change stated impacts the market ● B2a: Strategy 1 → Working → Ev1: Limitations/Trade-offs ● B2b: Strategy 2 → Working → Ev2: Limitations/Trade-offs ● Evaluate which strategy is most effective/suitable given the context of the question You should select one revenue strategy and one cost strategy. Main Type 2: Discuss whether (strategy) is the best/most effective/most suitable strategy to (effect) ● Link the effect given to a firm objective – Profits, Revenue, Cost, Market Share, Growth ● B1: Strategy 1 → Working → Ev1: Limitations/Trade-offs ● B2: Strategy 2 → Working → Ev 2: Limitations/Trade-offs ● B3: Strategy 3 → Working → Ev 3: Limitations/Trade-offs (IF TIME PERMITS) ● Evaluate which strategy is most effective/suitable given the context of the question 2

Main Type 3: Discuss how (strategy) adopted by (firm) would affect (effect) . Type 3a: Effect on Firms – Profits, Revenue, Cost, (Market Share, Growth) ● State that firms are profit maximising ● B1: Effects on Revenue based on Dd and |PED| changes → Link to Profit → Ev1: Condition for contradiction ● B2: Effects on Cost → Link to Profit → Ev2: Condition for contradiction ● Evaluate whether the effect on revenue outweighs the effect on cost; vice versa Type 3b: Effect on Society/Consumers – Allocative and Productive Efficiency, Variety, Consumer Welfare (Equity) ● B1: Effects on Allocative Efficiency (Society) ● B2: Effects on Income Equity (Society) ● B3: Effects on Productive Efficiency (Firms) ● B4: IEOS effects on equity (Consumers) ● B5: Effects on Innovation (Quality and Variety), linking to Dynamic Efficiency (Consumers) ● IN THIS ORDER. Bring in B2 and B3 only if government intervention is involved 3

Strategies Strategies can be classified in two ways: (1) Pricing and Non-pricing ● Pricing Strategies involve the firm changing the price it sells its product at. ○ Lowering Prices, Increasing Prices, Third Degree Price Discrimination. ● Non-pricing Strategies are all other strategies. ○ Product Differentiation, Merger, Acquisition, Collusion, Cost Reducing, Diversification, Relocation and Cognitive Bias strategies (2) Revenue and Cost ● Revenue Strategies are strategies that cause shifts in the firm’s average revenue (AR) curve. ○ Product Differentiation, Merger, Acquisition, Collusion, Lowering Prices, Third Degree Price Discrimination, Cognitive Bias Strategies ● Cost Strategies are strategies that cause changes in the average cost (AC) of production. ○ Cost Reducing Strategies, Diversification, Relocation 1. Product Differentiation 1.1 What is Product Differentiation Product Differentiation is the process of creating differences, real or imaginary, between a firm’s products and its rival firms’ products. This is done so as to distinguish a firm’s products from its rival’s products. Real Product Differentiation exists when there are actual differences between rival firms’ products. Imaginary Product Differentiation exists when there are perceived differences between rival firms’ products due to imperfect information. These forms of differentiation are not mutually exclusive. 4

1.2 Examples of Product Differentiation (i) Product Development Product Development refers to the improvement of an existing product or its presentation, or developing a new product to target a particular market segment. It is considered as real product differentiation. (ii) Innovation Innovation is the process of creating new ideas, products, methods or ways of doing things. This usually involves firms engaging in Research and Development (R&D). It may be considered to be a more extreme form of product development, and is therefore also considered as a form of real product differentiation. Product Innovation refers to the development and introduction of new products or improved versions of existing products with significantly better features . Process Innovation refers to the improvement of production processes to improve efficiency. (Process innovation is elaborated on in 5. Cost Reducing Strategies) The extent to which firms engage in R&D depends on their ability to innovate and their willingness to innovate . The ability to innovate is dependent on the firm’s level of profit in the long run while the willingness to innovate is dependent on the level of competition faced. A firm may also become more willing to innovate with the advent of disruptive technologies, or due to rival firms’ patents on products. Perfect Competition Monopolistic Competition Competitive Oligopoly Monopoly Ability None Low High High Willingness None High High Low or High Fig 1: the willingness and ability of firms in different markets to engage in innovation 5

In answering questions, it is important to analyse whether a firm will be willing and able to innovate. As shown in Fig 1 above, realistically, only firms in a competitive oligopoly will undoubtedly engage in innovation. Firms in MC may engage in less drastic forms of product development instead. Firms in PC will never engage in innovation. A monopolist has the ability to engage in innovation. However, their dominant position in the market may reduce their willingness to innovate as the monopolist is already the most dominant firm and is not concerned about gaining market share and market power. However, the threat of potential entrants may incentivise monopolists to innovate since as a form of BTE in order to maintain their dominance in the market. Moreover, the invention of better products would increase tastes and preferences for the monopolist’s product, incre