ASRJC Theme 2A Firms' Strategies Lecture notes 2025

THEME 2: Firms’ Strategies and Market Failure Anderson Serangoon Junior College Economics Department A 1 THEME 2: FIRMS’ STRATEGIES AND MARKET FAILURE SYLLABUS CONTENT (H3)

THEME 2: Firms’ Strategies and Market Failure Anderson Serangoon Junior College Economics Department A 2 THEME 2: FIRMS’ STRATEGIES AND MARKET FAILURE CHAPTER 1: FIRMS’ STRATEGIES 1. STRATEGIES TO DEVELOP COMPETITIVE ADVANTAGE ➢ EFFICIENCY AND EQUITY • X-INEFFICIENCY • EQUITY • SOCIAL EFFICIENCY: ‘PARETO OPTIMALITY’ ➢ FIVE FORCES STRATEGIC MODEL • DETERMINING COMPETITIVE ADVANTAGE • ACHIEVING COMPETITIVE ADVANTAGE 2. STRATEGIES WITH RESPECT TO OTHER FIRMS’ DECISIONS ➢ COMPETITION AND COLLUSION • TACIT COLLUSION: PRICE LEADERSHIP • FACTORS FAVOURING COLLUSION • NON-COLLUSIVE OLIGOPOLY ▪ THE BERTRABD MODEL ▪ THE COURNOT MODEL ➢ GAME THEORY • SIMULTANEOUS AND SEQUENTIAL GAMES • COOPERATIVE AND NON-COOPERATIVE GAMES • THE THREE ELEMENTS OF GAMES • RISONER’S DILEMMA • PRICE COMPETITION • ADVERTISING Anderson Serangoon Junior College JC2 H3 Economics 2025

THEME 2: Firms’ Strategies and Market Failure Anderson Serangoon Junior College Economics Department A 3 Firms’ Strategies and Market Failure Overview In Theme 2, the decision-making approach will be explored further as we look into firms and their strategies, markets and market failure. In Theme 2.1.1͕, we look at firms’ strategies to achieve their primary goal of maximising profits. First, we will examine the economic aspects of Michael Porter’s Five Forces model and how it can be applied to help firms develop a competitive advantage. To a certain extent, firms have control over these decisions, but they cannot be made in isolation because they exist in dynamic market environments. We will thus look at how firms react strategically to each other’s decisions as we examine game theory and the economics of cooperation. Some important questions that will be explored are: • How does a firm develop competitive advantage in consideration of the nature and competitive intensity of the market? • What strategies should firms prioritise in their decision-making? • How do firms thrive in a dynamic market environment? • How should firms take into account the decisions of other economic agents in their own decision-making? 1. Strategies to develop competitive advantage Introduction In the theory of the firm, it is commonly assumed that the objective of the firm and its owner(s) is to maximise profits. As firms make decisions, these decisions will invariably affect firms’ profitability and efficiency as well as societal welfare. The different dimensions of efficiency include: • Productive efficiency • Allocative efficiency • Dynamic efficiency • X-inefficiency Economic efficiency says nothing about fairness or equity. A set of values and beliefs thus governs the choice of how equity should be defined. Examples of the views of equity include: • Utilitarian Approach • Contractarian Approach (Rawlsian Approach)

THEME 2: Firms’ Strategies and Market Failure Anderson Serangoon Junior College Economics Department A 4 Societal welfare is typically defined as the summation of consumer and producer surplus in H2 Economics. The existence of market failures will create deadweight loss to society thereby prompting the possibility of government intervention. Firms develop competitive advantage in consideration of the nature and competitive intensity of the market through analysis of competitive rivalry within an industry, bargaining power of suppliers, bargaining power of customers, threat of new entrants and threat of substitute products. Firms often use competitive strategic analysis in marketing and strategic management to assess strengths and weaknesses of competitors within the market. With this analysis, firms implement strategies that will provide them with a distinct advantage over their competitors and enact barriers to prevent competitors from entering the market. Strategies of Firms includes: • Advertising • Research and Development • Innovation • Outsourcing • Patents • Other Entry Limiting Behaviour Efficiency and Equity Microeconomics is concerned with the allocation of scarce resources: with the answering of the what, how and for whom questions. But how satisfactorily will these questions be answered? Clearly this depends on society’s objectives. There are two major objectives that we can identify: efficiency and equity. Efficiency. If altering what was produced or how it was produced could make us all better off (or at least make some of us better off without anyone losing), then it would be efficient to do so. For a society to achieve full economic efficiency, three conditions must be met: Efficiency in production (productive efficiency) • This is where production of each item is at minimum cost. Producing any other way would cost more. It is the least-cost combination of factors for a given output or the maximum output for a given cost of production. Efficiency in consumption. • This is where consumers allocate their expenditures so as to get maximum satisfaction from their income. Any other pattern of consumption would make people feel worse off. Efficiency in specialisation and exchange. • This is where firms specialise in producing goods for sale to consumers, and where individuals specialise in doing jobs in order to buy goods, so that everyone maximises the benefits they achieve relative to the costs of achieving them.

THEME 2: Firms’ Strategies and Market Failure Anderson Serangoon Junior College Economics Department A 5 These last two are collectively known as allocative efficiency. In any economic activity, allocative efficiency will be increased as long as doing more of that activity (and hence less of an alternative) involves a greater marginal benefit than marginal cost. Allocative efficiency will be achieved when all such improvements have been made. Economic efficiency is achieved when each good is produced at the minimum cost and where individual people and firms get the maximum benefit from their resources. Equity Equity is where income is distributed in a way that is considered to be fair or just. Note that an equitable distribution is not the same as an equal distribution and that different people have different views on what is equitable. Even though the current levels of production and consumption might be efficient, they could be regarded as unfair, if some people are rich while others are poor. Another microeconomic goal, therefore, is that of equity. Income distribution is regarded as equitable if it is considered to be fair or just. The problem with this objective, however, is that people have different notions of fairness. A rich person may well favour a much higher degree of inequality than will a poor person. Likewise, socialist governments will generally be in favour of a greater redistribution of income from the rich to the poor than will conservative governments. Equity is therefore described as a value judgement: notions of equity will depend on the values of individuals or society. • SDL: QR code for information on Utilitarianism Source: http://www.rsrevision.com/Alevel/ethics/utilitarianism/index.htm

THEME 2: Firms’ Strategies and Market Failure Anderson Serangoon Junior College Economics Department A 6 X-inefficiency The major criticism of monopoly has traditionally been that of the monopoly’s power in selling the good. The firm charges a price above MC (see the Figure below). This is seen as allocatively inefficient because at the margin consumers are willing to pay more than it is costing to produce and yet the monopolist is deliberately holding back