Firm Loss Why a Firm Operate Experiencing Essay

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Firm loss why a firm operate experiencing a loss. Explain law diminishing returns economics. Give a personal diminishing utility. Give summary economic costs. In short-run, a firm operates a loss. How McDonald's operate a competitive market.

Why would a firm still operate when they are experiencing a loss?

Logically speaking, it might seem intuitive that a firm would not wish to continue to operate within a given market if it was experiencing a loss of profits. An example of such an inevitable 'loss' occurs when a firm is operating in a perfectly competitive market. In such a market, market entry and exit is extremely fluid. Producers must price products extremely low, giving consumers a great deal of flexibility over choice. To secure valuable consumer dollars, producers will have to fight aggressively for market share, including slashing prices to the point that their profits do not cover their overhead.

A firm stays in such a market with the hopes of creating a marketplace that is no longer 'perfectly competitive.' "To gain greater control over prices and profits, firms may undertake expensive advertisement campaigns so that customers perceive differences between the products of that firm and its competitors" (Kaplan 1999). For example, a town with many pizza parlors may have trouble securing a loyal customer base. To shift its position in a perfectly competitive marketplace, the pizza parlor may temporarily operate at a loss, advertising the superior quality of its cheese and crust, the fact that it offers delivery and its competitors do not, or special toppings that can secure a loyal and specific market niche (such as consumers who prefer whole wheat or need gluten-free pizza). If the pizza parlor continues to advertise, eventually it may draw enough customer 'traffic' to offset its early losses.

Firms usually struggle to compete on price alone in a perfectly competitive market, given that the easy entry and exit into the marketplace means that initial 'first movers' will often price their products at rock bottom, in the hopes of gaining a new customer base. But if firms continue to behave this way, new entrants will always be pricing older firms out of the market. Usually, some special value offered to the customer is necessary in a highly competitive market, conveyed by a firm's specific brand name or focus on a niche consumer. In the food and beverage industry, which his highly competitive, certain firms such as McDonald's and Burger King have established themselves to the point where consumers will specifically seek them out, because they like the predictable taste of the product.

However, the ability to easily enter and exit from a market may shift, and firms may hold on, while still operating at a loss, in hopes that the industry structure may change in their favor. If it becomes more difficult to enter a market (for example, if the costs of starting a business in the area go up) and the number of competitors becomes more limited, then firms can exercise greater discretion over prices and hopefully make a profit. A firm may also be able to expand its production facilities in the long-term and operate on an economy of scale, offering cheaper prices than its competitors because of its ability to produce at large volume.

Explain the law of diminishing returns in economics

The law of diminishing returns is a description of the short-term limitations of a firm to expand, even when faced with an increase in the price it is able to command. "If the variable factor of production is increased, there comes a point where it will become less productive and therefore there will eventually be a decreasing marginal and then average product" (Law of diminishing marginal returns, 2011, Investopedia). For example, in a factory, the costs of operating the factory in terms of labor and overhead, as well as input goods will eventually become too high, and the firm will have to limit supply. There also may be some logistical obstacles. "If capital is fixed extra workers will eventually get in each other's way as they attempt to increase production. E.g. think about the effectiveness of extra workers in a small cafe. If more workers are employed production could increase but more and more slowly" (Law of diminishing returns, 2010, Economics help). The law of diminishing returns, however "only applies in the short run because in the long run all factors are variable," and a firm can always add to its production facilities if the increase in demand is sustained. It can even reconfigure the facilities to create more efficient standard operating procedures for workers.

Give a personal example of diminishing utility

The idea of diminishing utility reflects the fact that every addition of each additional good or service is of less utility to the consumer than that of the previous one, after a certain point. "As a person increases consumption of a product - while keeping consumption of other products constant - there is a decline in the marginal utility that person derives from consuming each additional unit of that product" (Law of diminishing marginal utility, 2010, Economics help). A good example of this can be seen with the purchase of steak. A person might derive great pleasure from eating a good steak once a week. The steak also provides protein and other necessary nutrients for the individual. The consumer may one day decide that he derives such enjoyment from his weekly purchase of steak that he desires to eat steak twice a week.

Assuming that his income has remained constant, the fact that the eater is devoting more of his budget to steak means he must cut back on other products, such as his purchase of sushi or takeout meals. If he is a real steak enthusiast, this sacrifice might be worthwhile for him. If he wishes to increase his consumption to three or four times a week, however, he may have to cut back even more on other items in his food budget. Perhaps he buys less fresh fruits and vegetables, or generic rather than brand-named cereal. If he decides to eat steak four or five days a week, his food budget (no pun intended) will begin to 'eat into' other aspects of his discretionary income. He may have to cut back on going to the movies and cable television. Eventually, at some point, the pleasure derived from the extra steak will be less than the pleasure he could gain from the other foods and entertainment he had to eliminate to eat so much steak.

There is also a loss of pleasure that must be factored in to the law of diminishing utility. The pleasure the man may have gotten from the steak once a week may have indeed been very great, but every additional meal offers less value, because after a certain point, the steak becomes commonplace. Finally, the man may begin to experience some negative health consequences by cutting back on fruits and vegetables in his budget to buy the steak.

Give a brief summary of economic costs.

Economics is often described as the science of scarcity. There are always opportunity costs when an individual makes a particular economic decision. When someone makes the purchase of a new car, he or she must sacrifice the opportunity to go on vacation with that money or to buy another type of vehicle. "Opportunity costs refer to the alternative taken into consideration by decision makers who might want to choose the line of activity which minimize the costs. From an external point-of-view, it is difficult to ascertain which the alternative is considered" (Piana 2003). Opportunity costs differ from real costs, or the costs of operation or consumption. It is also different from discretionary costs which might not be directly related to production but are still necessary (like the costs of advertising a new product). When evaluating the financial cost of an item, a supplier often divides costs into the categories of fixed costs (which are not responsive to production loads, like the cost of rent) and variable costs (like input costs and the costs of labor) and may also consider potential opportunity costs (Piana 2003).

In the short-run, why might a firm still operate even when there is a loss?

Because of the principles of the law of diminishing returns is a purely short-term phenomenon, firms may operate at a loss in the hopes of adding to their production facilities or investing in new technology that will enable them to operate at lower costs. An expanded firm can more easily operate on an economy of scale, and make a profit. Although in the short-term expansion is difficult, according to the laws of economics, in the long-term, the possibilities of expansion are endless. Changes in the industry structure and improvements in technology (either through new investments or changes in the culture) can also result in improved profitability. For example, a lawn and landscaping firm may initially attempt to make market inroads with relatively meager equipment, limiting their ability to…[continue]

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