In the recent years, UK banks have been unable to support SME’s into expanding their business due to austerity measures. As a result, GM like other small entrepreneurship ambition to expand have been put on hold and the companies are now starving for finance and struggling to access cash from lenders.
Bearing those issues in mind, the development of a comprehensive turnaround plan that include short-term profit gains and long-term initiatives for sustained growth has become mandatory. Simple changes could make a world of a difference. Below are some economic theories that will help GM better understand their business and the economic factors affecting it.
1. Opportunity cost - GM is making losses and wants to diversify into its own chain of retail shops. Such a decision involves an opportunity cost. For instance, funds which were previously meant to be used to buy machines and materials will be diverted into setting up new shops. This may lead to a fall in production and a decrease in output and revenue.
2. Economic efficiency - Investing in new and sophisticated machinery will help to reduce cost of production i.e. AC will fall and this will improve production efficiency. Falling costs will help GM to become more competitive in the market by charging lower prices while maintaining its profits level. Lower prices may even drive competitors out of the market if GM is acting as a price leader in the market. If GM wants to go ahead with its plan to invest in retail chain then it will be very difficult to invest in machinery. It will not be able to reduce cost and may not become competitive and hence may lose its market share.
3. The law of supply and demand
Although there is freedom of entry, GM is operating under an imperfect market of monopolistic competition since there are differentiated products. The firms have sufficient market power and they are price makers.
3.1 Supply theory - Can costs be reduced to make it possible to supply more at every price? How do increased costs affect the GM supply curve and profit?
Increasing costs will lead to a fall in SS.
Increasing cost will lead to increasing prices and makes GM less competitive in the market. It will lose its market shares and continue to make losses. In order to become productive, GM has to reduce its costs by eliminating unnecessary expenses. It can actually give training to its workers to increase supply so that price falls.
The entry of new firms has led to excess supply in the market and the market forces of demand and supply have pushed prices of GM down.
3.2 Demand theory - GM recognises that demand is actually falling due to new competitors in the market. The internet has taken over life of people and the shops are struggling to cope with online sales. If GM do not have the fund to have a user friendly and well-marketed website, then it may be struggle in the retail business. Customers want value for money at the lowest possible price.
4. Monopolistic competition - Due to the fact that GM is selling differentiated products, each firm in the market acts as a virtual monopoly. This means that each firm can decide which price it will charge to consumers. But if facing a downward sloping demand curve, in order to increase sales a firm will have to reduce its price. The diagram below shows that GM is actually making losses.
Although GM is making losses it does not mean that it should close down. This decision is based on AVC rather than ATC. As long as GM is charging a price above its AVC, it is advisable to continue operating because closing down will lead to greater losses. In this case, the firm is not maximising its profits but rather minimising its loss.
5. Elasticity & Equilibrium - Price elasticity of demand measures the responsiveness of demand after a change in price whereas equilibrium is a situation in which opposing forces balance each other out (Parkin et al. 2005, p. 64). Demand can be made less elastic…