economics 25 mark essayWatch
Wondering if anyone would be interested in reading this essay? I am in year 12 studying AS economics and this is an A2 essay question so it may not be perfect, but it may be of help to someone. I would also really appreciate any feedback!
The diagram is obviously not included here but it is a perfect competition diagram showing both the individual firm and industry.
Evaluate the view that a firm making low profits must be inefficiently managed. (25 marks)
In order to evaluate the above opinion it is imperative to define what Is meant by ‘low profits’. In economic theory, normal profit is considered to be £0, or the breakeven point, whereas anything above £0 is considered supernormal prints. Therefore, for the purpose of this essay, I will take ‘low profits’ to mean normal profits, although in reality what is considered low may differ from this proposed definition and largely depends on the firm in question. There are many reasons why a firm may be making low profits in the short term, or even the long term, asides from inefficient management.
It is assumed in general economic theory that profit maximisation is the primary objective of all rational firms. However, in reality there are many other objectives that may be adopted by a firm depending on their current and future goals and the needs of various stakeholders. A firm may have a short term core objective of sales maximisation (growth) in order to flood the market and raise brand awareness, or may focus more on social and ethical responsibilities. Public sector firms will also have differing objectives from private sector firms, as their goal is to maximise societal welfare. There is a plethora of reasons why a firm may opt not to profit maximise: they may be profit satisficing (that is, sacrificing profit to satisfy as many key stakeholders as possible), be attempting to avoid scrutiny from regulatory bodies such as the CMA, or may simply lack the knowledge of where profit maximisation occurs (MC=MR). It is impossible to conclude that a firm making low profits is inefficiently managed if making profit is not what the firm is aiming to do.
If, however, the objective of the owners of the firm is to profit maximise, the divorce of ownership from control and the principal agent problem can help to explain why the firm may not be meeting that goal. These terms describe a scenario in which the owners of the firm are not the same people who control the business on a daily basis, ie. the managers. This creates conflicting objectives as the managers pursue their own objectives due to self-interest, for example, taking elongated breaks to increase leisure time at work, therefore, the owners objective of profit maximisation is not prioritised. In such a case, one would conclude that the firm is inefficiently managed.
The market in which the firm is operating, and the degree of competition present in that market, must also be considered before attributing low profits entirely to managerial inefficiencies. In a monopoly market supernormal profits are often persistent; since there are no alternatives or substitutes, consumers must buy from one specific firm if they wish to purchase the good/service. Thus, supernormal profits may be an indicator of monopoly power rather than good management. If a profit maximising monopolist is making low profits, then one could conclude with some certainty that it is inefficiently managed, perhaps due to excessive bureaucracy and diseconomies of scale, or x-inefficeny.
Conversely, if operating in a perfectly competitive market, firms are price takers and therefore normal profit will be the default position; if they attempt to raise prices demand will fall due to the high level of substitutes. The diagram below illustrates this occurring: the supernormal profits being made at D1 will encourage other firms to enter the market, shifting supply to the right from S1 to S2. This creates a new equilibrium with price P2, which the individual firm must adopt as they are price takers. Thus, despite the firm operating at the profit maximising point where MC=MR, normal profit is made in the long run. Whilst perfect competition is a theoretical extreme, this principal holds true for all competitive or contestable market structures, therefore, the absence of high profits does not necessarily correlate with inefficient management in such situations.
Even if a firm has an objective of profit maximisation, and the market within which they operate allows for supernormal profits to be made, some industries are inherently less profitable than others. A natural monopolist is one example; because there are such high fixed costs associated with natural monopoly markets, such as water and utility distribution, the only way for such firms to remain profitable is to exploit consumers by charging extortionate prices. However, since these monopolies often occur in essential product markets, the government imposes regulations on such firms to prevent excessive prices being charged, and ensures the natural monopoly makes normal profit by providing financial assistance in the form of subsidies. Natural monopolists, therefore, are unable to make anything but low profits regardless of the quality management, although one might conclude that it is inefficient to enter into a market where supernormal profit is unattainable, if it is your objective to make said supernormal profit. It is thus vital to contemplate the role government intervention plays in hindering profitability. High levels of corporation tax and windfall taxes could mean a firm is only able to make low profits. Alternatively, some firms may disguise profitability to avoid paying a larger proportion of tax, thus a firm seemingly making low profits is very efficiently managed if profit maximisation is their main objective.
The view that a firm making low profits must be inefficiently managed is incorrect in that the conclusion does not necessarily follow from the premise. A firm making low profits may be inefficiently managed, however, there are so many other explanations to the firms profitability, or lack thereof, such as the age of the firm, their objectives, the market structure and sector within which they operate and government policies and regulations that are in place . The state of the economy also massively affects the level of profits which businesses are able to make; in a recession nearly all firms will be making low or negative profits; this is not a reflection of their management but an impact of external forces. Equally, supply-side shocks can limit profitability beyond control of the management, such as environmental or public health disasters. Crucially, a time frame must be established to hold the opinion explicit in the question when consumer needs and wants are constantly changing. What is profitable today may not be tomorrow and vice versa. The level of profit made by a firm depends most on the effective demand for the good which they supply, regardless of how efficiently the firm is managed.
The essay is good - you have outlined your definitions, employed diagrams, showed grasp of theoretical concepts, great breadth of analysis, and outline exceptions to the rule.
I am not sure what the essay is for though - is it a mock exam question? Is it for your teacher?
If it's a mock exam answer, it could be a lot more concise. It will be challenging for you to replicate the entire essay in exam conditions. Also, I don't know what the mark allocations are for this answer.
If you are taught the names of particular models, it will be useful to mention them. As economics is heavy on theory, it's unlikely people have not came across the idea.
Although there is some critical thinking shown, I would add a bit more where possible.
Hope this helps