Theory of the Firm

The number of firms within an industry is important because the behaviour of firms may differ according to the degree of competition they face.

Industries may consist of: –

• Large numbers of small producers, producing identical products (Perfect competition)

• Large numbers of small producers, producing non-identical products (monopolistic competition)

• A few large firms which control most of the production within an industry (oligopoly)

• One producer who dominates the industry and many small producers (monopoly)

Single Product – Multi-Product Firms

Firms can be categorised in two ways; firms, which are producers of one product and firms which produce a range of products.

A ‘product’ may be the manufacture of cars, kitchen equipment or cereal crops.

Examples of multi-product firms might be a farm rearing livestock and producing arable crops, or, a firm that makes pharmaceuticals and produces paint.

Multi-product firms behave differently to single-product firms. Multi-product firms find it difficult to allocate costs accurately to each product.

The price of products may be affected according to how costs have been allocated.

Multi-product firms may cross-subsidise products – charging a higher price for one product and a lower price for another. It may do this in order to increase market share, force rivals out of the industry, avoid taxes etc.

Product Characteristics

Branded Products

Some products can be made distinctive, so that a customer is able to distinguish one firm’s product from another. These products are differentiated. One way of differentiating products is to use a brand name.

Examples of differentiated products:

• Heinz Baked Beans
• Levi Jeans
• Coca Cola
• Esso Petrol
• Bic pens
• Daz
• British Airways

Branded goods create a particular product image. This is advantageous for the individual firm:

• Consumer Loyalty
• Consumer willingness to pay higher prices – lower price elasticity of demand

Homogenous

An alternative to differentiated products are those which are identical e.g. they are homogenous

Examples of homogenous products are:

Potatoes, carrots and other foodstuffs – products that are frequently sold loose (unpacked) in shops.

Consumers are unable to distinguish between goods produced by different producers. As a result homogenous products will have a higher price elasticity of demand.