Business Studies Case Study on Production and Cost

Decision-making is among the most imperative tasks for any entrepreneurs. It involves the calculation of risks, opportunities, profits, and gains that may result from the decisions undertaken by the business. It is for this reason; therefore, that decision-making holds an essential spot in entrepreneurship. At the core of decision-making is a reward, whose attainment requires sacrifice and trade-offs (Jones 33). Notably, both businesses and individuals undertake the decision-making process; however, while some personal decisions may not involve some monetary aspects, business decisions always involve money. Consequently, economic decision-making as a process involves the use of accounting information. The accounting information as part of the decision-making process helps in the understanding of the business and economic environment within which the business operates. Often, economic decision-making for businesses involves asking several questions, especially where production is involved. Decision makers within an organization must, therefore, ask whether there will be pay, the day of payment, and the amount paid (Jones 37). Knowing this information is essential as it helps in planning for the funds and taking remedial measures in case the funds do not arrive as budgeted for. Another factor in the decision-making process is the market model/structure within which the business operates. Each market model has its inherent specifics, which affect the decision-making process for an organization. In discussing economic decision-making, this paper will focus on the various economic decision-making within the various market models/structures that include perfect competition, pure monopoly, monopolistic competition, and oligopoly.

Market Structures/Models

Market structure denotes the composition/set up of the market concerning different factors. The factors that determine a market structure include long-run economic profit, information of products within the market, nature of the product, collusion, a company’s control over the price of the product, entry, nature of the product, and the number of firms (Bernell 113). In reference to these factors, market structures can be perfect competition, a monopolistic competition, an oligopoly, or a monopoly. The degree of competition within each market structure differs, with a perfect competition having maximum competition, while a monopoly has zero competition (Bernell 113).

The first market structure is perfect competition. It is worth noting that perfect competition is a non-existent market structure and that most of the assumptions and characteristics of the structure are substantially a benchmark for understanding other market structures (Bernell 113). Within a perfectly competitive structure, the conditions include the presence of many small firms. For this market, each of the many small firms produces an insignificant part of the total production within the market. The firms’ insignificant production means that none of the firms has control over the market price. Additionally, within such a market, there are many small buyers, with no buyer (or group of buyers) having control over the market price (Bernell 113). A perfectly competitive market additionally has significant freedom of entry and exit, thus making both buyers and sellers within the market structure free to either join or leave the market without substantial repercussions on the market or individuals.

Another feature of a perfectly competitive market is the homogeneity of the products. In this case, it is difficult to distinguish between products of firms operating in the market. Moreover, firms “take” or set the prices of products they sell from the market. The market achieves pricing equilibrium from the number of transactions given the vast number of buyers and sellers (Bernell 114). Price taking, as a feature of the perfect competition, means that firms cannot sell at prices higher than the market prices, or lower than market prices since no one will buy the products or the firms will all lower their prices, causing them to earn fewer profits. In earning profits, firms in a perfect competition have zero economic profits; essentially the firms earn enough to cover their cost of production and opportunity cost for the investment made in the venture (Bernell 115).Finally, within such a market structure, consumers have perfect knowledge of the choices available to them, striking out the chance of firms claiming their goods are better, faster, or cheaper.

The monopolistic competitive market structure, on the other hand, is the opposite of perfect competition. Within a monopolistic market structure/model, there is only one seller. Among the reasons for the existence of such a structure is ownership of all or some resources by a single entity; permission by the government as is the case in other countries where airlines, railways, utility company are government-owned monopolies; and the existence of a physical reason for the monopoly to thrive (Bernell 116). The reason, in this case, could be that a company is the sole provider of a good or service in a small town since it is the only entity with established infrastructure in the particular area. Firms in a monopoly can set high prices, produce lower quality products and services, and have higher profit levels given that there are no firms to drive down prices or produce competing products or services for innovation and improved quality of products and services.

Contrary to a monopoly, an oligopoly refers to a market structure in which firms have competition, but among only a few players in the market. Companies within an oligopoly produce similar, but none is a perfect substitute for the competitor’s products (Bernell 118). Within an oligopoly, therefore, each firm can have an influence on the market share of the other given the interdependence among the firms. Consequently, any change in the price of products of one business within the market structure means that other businesses must make changes in their price and output (Bernell 118). Further, within such a market, there is a heavy reliance on advertising and other promotional measures as a means of gaining market share. To further gain market share, businesses within the market focus on product differentiation; where any discernment by the customer becomes an advantage to the business as it can then have a monopoly over the price and output determination stemming from the slight differentiation.

Monopolistic competition as a market model fuses the characteristics of monopoly and perfect competition. For a large part, monopolistic competition thrives on product differentiation, where the sellers differentiate their products and services to stand out from the rest of the competitors (Bernell 119). The differentiation is mostly because of the presence of many buyers and sellers in the market, even as the sellers have a relatively small market share. The quest for differentiation, however, works to the disadvantage of the firms as it reduces the likelihood of cost minimization given that all businesses within the market push to produce “over the top” products and services, resulting in the businesses incurring high costs of production. Moreover, firms within a monopolistic competitive market structure are price setters as opposed to the price taking feature of perfect competition. Price setting works in the market given that companies have their demand curves; allowing the companies to set relatively higher prices in comparison to perfect competition (Bernell 119).

Decision Making in Different Market Models

The different market structures within which a business operates determine the economic decisions the business can take within the given market structure and demands of such a structure. Within a perfect competition market structure, a perfectly competitive firm mainly has one economic decision to make- the amount of quantity to produce (Taylor et al.). The decision for a business operating in perfect competition is necessarily made for the business since product prices are set by market supply and demand. Given this fact, it means that any quantity of output from the business will sell at the same price, as the products have an elastic demand curve. This essentially means, “Buyers are willing to buy any number of units of output from the firm at the market price” (Taylor et al.). For the business, it means that an increase in the number of units sold also increases the total revenue made by the firm.

Within a perfect competition market structure, Taylor et al. argue that any quantity produced by a business entity will result in profit. In calculating profit, total revenue minus the total cost of production should equal a profit. The decision in this case, for the business, is to determine the most profitable quantity to produce. Taylor et al. contend, “One way to determine the most profitable quantity to produce is to see what quantity total revenue exceeds total cost by the largest amount” (n.p.).

Most current decisions by firms depend on data. Ideally, all economic decisions made by firms rely on financial data given the reliability and effectiveness of such data in extrapolation. However, even in the presence of the data, it may not be enough to help in drawing complete total cost curve for all the levels of production (Taylor et al.). The lack of data thus calls for decision-making that involves experimentation in either lowering or increasing the levels of production and observing the effect of the two on profitability. Taylor et al. inform of the practice, “In economic terms, this practical approach to maximizing profits means looking at how changes in production affect marginal revenue and marginal cost” (n.p.).

Given that the purpose of any business is to make a profit, within a perfect competition market structure, firms must make decisions on whether to enter or exit the market. An analysis of revenue and marginal costs can help firms make that decision, particularly on the exit of the firm from the market for already operational businesses. For already operational businesses, profits are the incentives the business has to expand its existing sites or open new locations for business (Taylor et al.). Similarly, profits attract other businesses into the market seeing other players making profits from their businesses. Profits, therefore, attract and assist in the decision to enter the market for new businesses, even as they encourage expansion and increased productivity among existing businesses within the industry and market.

While profits inform decision into entry and expansion in the market, losses “are the black thundercloud that causes businesses to flee” (Taylor et al. n.p.). Losses have an effect in the short run and long run decision-making for businesses within the perfect competition market. Thus, although businesses may be making losses, they may make the short run decision to keep going, especially when revenues cover variable costs. However, firms can only take so much in losses; thereby, in the long run, most will consider shutting down. Even in shutting down, while some may stop production altogether, others may only shut down part of their production as a way of minimizing losses, while weathering the storm hoping for an improvement in the market demand.

There are, however, possibilities of shifts within the perfectly competitive market that come with the entry and exit of firms into the market. These shifts significantly affect the decision-making process for firms in the market. The shifts, in this case, involve firms seeking to maximize their profit and consumers who seek to maximize their utility of the products within the market. Taylor et al. inform that when such a combination occurs, “the resulting quantities of outputs of goods and services demonstrate both productive and allocative efficiency” (n.p.). Essentially, what this means is that firms decide to produce without waste. The resulting market forces result in allocative efficiency, where firms not only make a decision and work to maximize their profits, but also “assure that the benefits to consumers of what they are buying, as measured by the price they are willing to pay, is equal to the costs to society of producing the marginal units, as measured by the marginal costs the firm must pay” (Taylor et al. n.p.).

Similar to the decision in perfect competition market, relying on variables such as marginal cost, average cost, total, fixed and variable costs, decision-making in a monopolistic market relies on these factors. Although monopolies have free reign over the prices they charge on their products and services unlike in perfect competition, demand for product or service constrains prices a firm charges for the product or service (Taylor et al. n.p.). Given the role of consumers in the price, monopolies have three options for their pricing. The first is charging a high price for low quantity; a low price for high quantity; or an intermediate. The decision to choose an intermediate, therefore, stems from the fact that setting the price too high may not bring in much given the low volume sold, while low prices will result in high quantities sold but with little in revenue. An intermediate, therefore, allows the firm to strike a balance between the price charge and the quantity sold. Moreover, such a decision has to consider the cost of production in total revenue and total cost incurred in production. Making such considerations help in gaining the highest possible revenue. The decision, herein, therefore, is not to maximize revenue, but sell the products at the highest possible revenue.

Decision-making remains a core feature of running a business. Right decisions lead to better performance for the business, while bad decisions can risk the entire existence of a business. The structure of the market, whether perfect competition, monopolistic, oligopoly, or monopolistic competition have a significant influence on the decision-making process of any firm. The influence covers not only the pricing of products but also the entry and exit of firms in the market.



Works cited

Bernell, Steph. Health Economics: Core Concepts and Essential Tools. 2016

Jones, Trefor. Business Economics and Managerial Decision Making. John Wiley & Sons, 2009

Taylor, Timothy et al. Principles of Economics. OpenStax, 2016