DSE Econ 攻略

February 20, 2023

【DSE Econ】Firms and production最齊精讀｜囊括所有背書內容【懶人包】

Public ownership

Firms owned by the government are called public enterprises. They are under public ownership.

There are two major forms of public ownership:

Public ownership	Government departments	Public corporation
Definition	A unit of governmental organization.	A firm which is wholly owned by the government, but it is not a unit of governmental organization but is incorporated by the statute.
Owner	The government	The government
Managed by	Government officials.	A board of directors appointed by the government.
Staff	Mostly civil servants.	Most are non-civil servants.
Financed by	The government.	Financially independent of the government.
Objectives	To provide public services for a low or no price.	To provide specific public services according to commercial principles.
Examples	Water Supplies Department/Housing Department/Hong Kong Post	Airport Authority/Hong Kong Science/Technology Parks Corporation

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Private ownership

Firms owned by private individuals are called private enterprises. They are under private ownership.

There are two major forms of private ownership, owners who bear unlimited liability and owners who bear limited liability.

Unlimited liability

Limited liability

Sole proprietorships

Partnerships

Limited companies:

² Private limited companies

² Public limited companies

(Listed companies)

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Unlimited liability

It means that owners’ liability is not confined to the amount of their investment in the firm, meaning that they may have to use their own assets or personal property to repay the debts that the firm incurs.

Limited liability

It means that owners’ liability is confined to the amount of their investment in the firm, meaning that they don’t have to use their own assets or personal property to repay the debts that the firm incurs.

Legal entity

A firm that is a legal entity has an independent legal status, it has a separate legal existence from its owners, and assumes all responsibilities, meaning that:

the firm can own property, make contracts, and engage in lawsuits under its own name.
the firm is fully responsible or its debts
the firm can continue to exist irrespective of ownership transfer, bankruptcy, or death of its owners.

If a firm is a legal entity, its owners bear limited liability.

If a firm is not a legal entity, its owners bear unlimited liability.

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Summarized features of the four types of private enterprises

	Unlimited liability			Limited liability
	Sole proprietorship		Partnership	Private limited company		Public limited company
Number of owners	1		2-unlimited	1 – 50		1-unlimited
Legal status	Not a legal entity			A legal entity
Continuity	Lack of continuity			Lasting continuity
Set-up procedure	Simple and cheap			Complicated and expensive
Sources of capital	Narrower	Wider		Wider	Widest
Separation of ownership and management	No			Yes
Specialization in management	No	Yes		No	Yes
Willingness to improve efficiency	Stronger			Weaker
Flexibility in decision making	Higher	Lower		Lower
Relationship with employees and customers	Closer			Distant
Disclosure of financial accounts	No need to disclose			No need to disclose	Need to disclose
Transfer of ownership	Free	Need consent		Need consent	Free
Profit tax rate	Lower			Higher

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Sole proprietorship vs Partnership

Sole proprietorship

It has only one owner and the owner is called a sole proprietor.

Partnership

It has two or more owners, and the owners are called partners.

	Sole proprietorship	Partnership
Similarities	1. Simple and inexpensive set-up procedure 2. No separate legal status 3. Unlimited liability 4. Lack of continuity 5. No separation of ownership and management 6. Stronger incentive to improve efficiency 7. Closer relationship with employees and customers 8. No need to disclose financial accounts 9. Lower profit tax rate (than private and public limited company)
Differences
1. Source of capital	Narrower source of capital	Wider source of capital
2. Scope of specialization	Narrower scope of specialization	Wider scope of specialization
3. Decision-making	Higher risk but more flexible in decision making	Lower risk but less flexible in decision making
4. Transfer of business	Freely transferable	More difficult to transfer its business
5. Sharing of costs, risks and profits	More difficult to transfer its business	Partners can share the costs, risks, and profits

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Private limited company vs Public limited company

Limited companies

They are private enterprises whose owners bear limited liability. The owners of a limited company are called shareholders.

	Private limited company	Public limited company
Similarities	1. Complicated and costly set-up procedures 2. Separate legal status 3. Limited liability 4. Lasting continuity 5. Separation of ownership and management 6. Higher profits tax rate
Differences
1. Number of owners	1-50 shareholders	1-unlimited number of shareholders
2. Issue of shares	Can issue shares but cannot invite the public for subscription	Can issue shares and can invite the public for subscription
3. Transfer of shares	Need to seek approval from the board of directors	Shares are freely transferable
4. Disclosure of financial accounts	No need to disclose its financial accounts to the public	(Need to submit its audited annual financial accounts to the Companies Registry.) The financial accounts are then available and disclosed to the public

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Shares and bonds

A certificate of ownership issued by a company which entitle its holder to a share of the company’s profits.

Bonds/debentures

A certificate of debt that entitles its holder to earn interest until redemption on the maturity date.

Comparison between shares and bonds

	Shares	Bonds
Roles of holders	Owners of a company	Creditors of a company
Voting rights of holders	Usually have voting rights at shareholders’ meetings	Do not have voting rights at shareholders’ meeting
Feature of returns	1. Shareholders receive dividends 2. Dividends may not be distributed 3. Dividends vary with the e company’s profits and dividend policy	1. Bondholders receive interest 2. Interest must be paid 3. Interest is usually fixed, whether the company earns a profit or not, interest has to be paid 4. Lower risk due to stable return
Maturity	No maturity dates	Redeemed on maturity dates
Priority in getting back capital upon liquidation	Shareholders are the last to get back their capital	Bondholders can get back their capital before shareholders

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Comparison between issuing shares and issuing bonds

Features	Issuing shares	Issuing bonds
Interest burden	No	Yes
Redemption obligation	No	Yes
Debt-to-equity ratio	Decrease, as it is easier to borrow new loans	Increase, as it is more difficult to borrow new loans
Influence on the company’s decisions	New shareholders may influence the company’s decisions and the existing shareholders’ control right over the company is diluted	Bondholders have no influence on the company’s decisions
Risk of being taken over	Increase	No influence

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Comparison between buying shares and buying bonds

Features	Buying shares	Buying bonds
Voting rights	Yes	No
Rate of return	May have a higher rate of return if the company earns more profits Yet, a lower rate of return may be resulted if the company earns less profits or even suffer losses	May have a higher rate of return if the company earns less profit or suffer losses Yet, a lower rate of return may be resulted if the company earns a lot of profit
Priority in getting capital refund upon liquidation	Lower priority than bondholders	Higher priority than shareholders
Risk of investment	Higher risk due to unstable income	Lower risk due to stable income

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Priority of payment upon liquidation of a limited company

Secured creditors (e.g., the bank with its mortgage) →Liquidator→Government and employees→Unsecured creditors (e.g., bondholders)→Shareholders

Classification of outputs

Goods

Tangible outputs of production.

Examples: books, food, drinks

Services

Intangible outputs of production.

Examples: transportation, banking

Consumer goods

Goods used to directly satisfy human wants.

Examples: textbook bought by students for acquiring knowledge

Producer/capital goods

Goods used to help (further) production.

Examples: textbooks used by teachers for teaching

Private goods

Rival(rous) in consumption: one’s consumption of the good would reduce the amount available for others’ consumption.

Excludable in consumption: one can exclude or prevent non-payers from consuming the good at an affordable cost.

Examples: apples sold in a market

Public goods

Non-rival(rous) in consumption: one’s consumption of the good would not reduce the amount available for others’ consumption.

Non-excludable in consumption: it is very costly to exclude or prevent nonpayers from consuming the good.

Examples: fireworks displayed in public area

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Types of production

Primary production

Activities which extract or directly use natural resources.

Examples: mining, fishing, farming

Secondary production

Activities which turn raw materials into semi-finished products or finished products.

Examples: construction, factory work

Tertialry production

Activities which provide services.

Examples: banking, education, transportation

Relationship between the three types of production

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Types of division of labour

Simple division of labour	Different workers specialize in producing different goods.	A driver specializes in driving; a baker specializes in baking
Complex division of labour	Different workers specialize I different production stages of the same good or play different roles in teamwork	In one school, teachers specialize in teaching, the principal focuses on management and the accounting clerk concentrates on accounting duties.
Reginal division of labour	Workers in different regions specialize in producing different goods or different production stages of the same good.	In the production of iPhone, the Us specializes in product design, and China specialize in manufacturing.

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Advantages and disadvantages of division of labour

Advantages

Disadvantages

1. Increase labour productivity for the following reasons:

A. Assign the most suitable person to do the right job

B. Practice makes perfect

C. Save time training and moving between tasks

D. More workers have capital goods to use

E. Stimulate mechanization

2. Raise capital productivity

3. Raise living standards

1. Work becomes boring

2. Loss of job satisfaction

3. Limited skills of workers

4. Greater skills of unemployment

5. Over-interdependence

6. Excessive standardization of products

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Factors restricting the extent of division of labour

Size of market

Market size↓→ Extent of division of labour↓

Nature of product

Production that requires individual creativity → extent of division of labour↓

Factors of production

	Meaning	Factor income/return
Entrepreneurship	Human effort provided by an entrepreneur in making production decisions and bearing risks	Profit
Labour	Human effort provided by a worker during production including worker’s physical and mental effort	Wages
Capital	Man-made resources used to help production	Interest
Land	Natural resources that can be used in production A gift of nature	Rent

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Different features of capital and land

Capital

Land

Features

1. Man-made resources

2. Human effort is involved

3. Capital formation/investment involves giving up present consumption for more future consumption

4. The amount can be increased to raise the productivity of other factors or to replace them

1. Natural resources

2. No human effort is involved

3. Its creation involves zero cost

4. Its supply cannot be increased artificially

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Labour supply

= Total number of working hours

= Number of workers x Average working hours of workers

Factors affecting labour supply

Population size↑
Working condition↑
Minimum working age ↓
Retirement age↑
Years of schooling or training↓
Attractions for immigration ↑ or restrictions↓

→Number of workers↑

→Labour supply↑

Number of public holidays↓
Number of days of annual leave and sick leave↓
Maximum working hours ↑

→Average working hours↑

→Labour supply↑

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Labour productivity

=𝑇𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 / 𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 ℎ𝑜𝑢𝑟𝑠

=𝑇𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡 / 𝐿𝑎𝑏𝑜𝑢𝑟 𝑠𝑢𝑝𝑝𝑙𝑦

Factors affecting labour productivity

Factor	Scenario
Health of workers	Better health → Labour productivity↑
Education and training	More/better education and training → Labour productivity↑
Incentive to work	Higher incentive to work → Labour productivity↑
Capital and technology	Better use of capital and technology → Labour productivity↑
Management	Better management → Labour productivity↑
Working environment	More decent working environment → Labour productivity↑

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Mobility of labour

Occupational mobility of labour

Geographical mobility of labour

Meaning

The willingness and ease of labour to change from one occupation to another

The willingness and ease of labour to move from one working area to another

Examples

The willingness and wish of a cook to change his job to become a teacher

The willingness and wish of a teacher to shift from a school in

Kowloon to a school in New

Territory

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Factors affecting occupational mobility

Factor	Scenario
Remuneration and working conditions	Better remuneration and working conditions → occupational mobility ↑
Entrance requirements	Relaxing entrance requirements → occupational mobility ↑
Retraining programmes	More retraining programmes → occupational mobility ↑
Market information	More transparent market information → occupational mobility ↑
Cost of changing job	Higher salary of the current job → have to forgo more income if change job → occupational mobility ↓
Extent of division of labour/specialization	Higher extent of division of labour/specialization → occupational mobility ↓

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Factors affecting geographical mobility

Factor	Scenario
Economic, political, and social conditions of different regions	Better economic, political, and social conditions → geographical mobility ↑
Immigration policies	Relaxing immigration policies → geographical mobility ↑
Transport network and transport cost	Better transport network and lower transport cost →geographical mobility↑
Market information	More transparent market information → geographical mobility ↑

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Methods of wage payment

Piece rate

Workers are paid according to the amount of their output.

Advantages

Disadvantages

To employers

Raising workers’ incentive to work and labour productivity

Lower cost of monitoring workers’ performance

Higher cost of calculating wage payments

Higher cost of monitoring product quality

To employees

Possible to get higher income

Unstable income

Time rate

Workers are paid based on their working hours.

Advantages

Disadvantages

To employers

Lower cost of monitoring product quality

Lower cost of calculating wage payments

Lowering workers’ incentive to work and labour productivity

Higher cost of monitoring workers’ performance

To employees

Stable income

Cannot ear more money by working faster

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Profit-sharing scheme/commission (usually with a basic salary)

A portion of the firm’s profit (or sales revenue) is distributed to workers as a wage payment.

Advantages

Disadvantages

To employers

Raising workers’ incentive to work and labour productivity

Lower cost of monitoring workers’ performance

Transferring some

business risks to workers

Higher cost of calculating wage payments

More difficult to recruit workers

To employees

Possible to get higher income

Unstable income

Tips

A gift of money paid by customers to reward workers.

Advantages

Disadvantages

To employers

² Raising workers’ incentive to work

² Lower cost of monitoring workers’ performance

² Higher cost of calculating wage payments

² More difficult to recruit workers

To employees

² Possible to get higher income

² Unstable income

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Comparison between different wage payments

	Piece rate	Time rate	Profit-sharing scheme/commission	Tips
To employers:
Workers’ work incentive and productivity	Higher	Lower	Higher	Higher
Cost of calculating wage payments	Higher	Lower	Higher	Higher
Cost of monitoring workers’ performance	Lower	Higher	Lower	Lower
Cost of monitoring product quality	Higher	Lower	Lower	Lower
Ease of recruiting workers	/	/	Difficult	Difficult
Transferring business risk from employers to workers	/	/	Part of the business risks can be transferred to workers	/
To workers:
Possibility of earning a higher income	Can	Cannot	Can	Can
Income stability	Unstable	Stable	Unstable	Unstable

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Conditions where a specific type of wage payment is preferred

Piece rate

It is commonly used in manufacturing industries where:
workers’ contribution can be easily measured.
product quality can be easily monitored.

Time rate

t is commonly used in service industries where:
workers’ contribution is too costly to measure.
high quality of work/product is required.

Profit-sharing scheme

For supervisors and managers whose performance is decisive to the firm’s profit and monitor.

Tips

For workers who provide direct services to customers.

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Capital stock

Change in capital stock

= Capital formation – Capital depreciation

Capital formation (investment)

It is the purchase or production of capital. Investment implies that present consumption is forgone for more future consumption.

Capital deprecation

It is the consumption or disposal of capital.

*The net increase in capital stock is called capital accumulation.

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Production cost

	Production costs
	Variable costs	Fixed costs
Meaning	Costs which change with output	Costs which do not change with output

Production runs/production periods

Short run

Long run

Meaning

Production involving both variable and fixed factors.

Production involving only variable factors.

Related concepts

The law of diminishing marginal returns:

When more units of a variable factor are continuously added to a given quantity of fixed factors, the marginal product of the variable factor will eventually decrease, other factors being constant (including technology).

² MP can decrease

after an initial increase.

² MP can decrease

initially.

Economies of scale:

Production scale↑ → Output↑ → Long run average cost↓

Diseconomies of scale:

Production scale↑ → Output↑ → Long run average cost↑

Optimal scale:

The production scale where the long run average cost is the lowest.

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Output calculation in the short run

Average product

= The amount of output produced by a unit of a variable factor on average.

=𝑇𝑃 / 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑓𝑎𝑐𝑡𝑜𝑟

Total product

= The amount of output produced by a given quantity of a variable factor.

= AP x Units of variable factor

= ∑MP

Marginal product

= The change in total amount of output caused by an additional unit of a variable factor

= TPn – TP(n – 1)

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Cost calculation in the long run

Average cost

= The cost of producing a unit of output on average.

=𝑇𝐶 / 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑜𝑢𝑡𝑝𝑢𝑡

Total cost

= The cost producing a given quantity of output.

= AC x Units of output

Marginal cost

= The change in total cost of producing an additional unit of output.

= TCn – TC(n -1)

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Internal economies of scale

When the production scale of a firm expands, the long run average cost decreases.

Technical economies	Large firm can more fully utilize its machines and afford more advanced machines → LRAC ↓
Managerial economies	Large firm can apply a wider scope of specialization among its managers and attract better managers → LRAC ↓
Financial economies	Large firm may borrow money from banks in a lower interest rate and is easier to issue shares to avoid paying interest → LRAC ↓
Purchasing economies	Large firm can buy in bulk and obtain a larger discount → LRAC ↓
Marketing economies	Larger firm can spread its advertising costs over a large output → LRAC ↓
Risk diversification economies	Large firm can diversify its input sources, products, and markets to spread its risks → LRAC ↓
Research and development economies	Large firm can spread its costs on R&D over a larger output → LRAC ↓

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Internal diseconomies of scale

When the production scale of a firm expands beyond the optimal scale, the long run average cost is raised.

Managerial diseconomies	When a firm keeps expanding, its organization may become too complicated. Decision may thus be delayed, and coordination may be weakened, lowering the managerial efficiency → LRAC ↑
Financial diseconomies	If a firm enlarges its scale by borrowing continuously, it may need to pay a higher interest rate to obtain capital since it is too risky for a bank to lend too much money to the same firm → LRAC ↑
Purchasing diseconomies	A continuously expanding firm may have to purchase more expensive resources or use more expensive substitutes → LRAC ↑
Marketing diseconomies	If a firm keeps expanding, existing markets may approach saturation. The firm thus need to pay a higher marketing cost develop new markets or promote new products → LRAC ↑

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External economies of scale

When an industry becomes larger, the long run average cost decreases.

Lower cost of recruiting and training workers	More workers would be attracted to the industry, employed, and trained. Thus, more experienced, and qualified workers will be available in the industry, lowering firm’s costs of recruiting and training workers → LRAC ↓
Lower cost of marketing and promotion	More people will know about the industry’s products, lowing the firm’s costs of marketing and promotion→ LRAC ↓
Lower cost of buying backup services	More related businesses will be developed, lowering the firm’s costs of buying back-up services → LRAC ↓
Lower transportation cost	Due to concentration of shops, goods can be delivered to shops more easily → LRAC ↓
Sharing of technology and production facilities	Production facilities, resources, technology and inventories can be shared among firms → LRAC ↓

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External diseconomies of scale

When an industry becomes larger, the long run average cost increases.

Increase in input prices	Excessive expansion of firms creates a huge demand for inputs, rising input prices, increasing the production cost → LRAC ↑
Saturation of existing market	Firms may need to develop new markets or promote new products, increasing the marketing costs → LRAC ↑
Increase in the cost of using back-up services	Higher demand for back-up services would increase the cost of these services → LRAC ↑
Heavy traffic and congestion	Concentration of firms may lead to heavy traffic flow and congestion, increasing the transportation cost→ LRAC ↑

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Expansion of firms

Internal expansion

It is the expansion of a firm on its own, e.g., setting up a new branch on its own.

External expansion/integration

It is the expansion of a firm by combining with another firm, e.g., by taking over another firm.

The four types of expansion

	Horizontal expansion	Vertical expansion		Lateral expansion	Conglomerate expansion
		Vertical backward expansion	Vertical forward expansion
Meaning	At the same production stage of the same product	At different production stages of the same product		Of related but not competing products	Of unrelated products
		At a preceding stage	At a later stage
Example: (Textbook factory)	Another textbook factory	Paper making factory	Bookstore	Magazine factory	Coffee shop

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Motives for the four types of expansion

Horizontal expansion	Vertical expansion	Lateral expansion	Conglomerate expansion
Enjoy economies of scale
More efficient use of resources
Increase market share Reduce competition (for external expansion only)	Make use of its brand name to sell other products
	Backward: Secure the supply of inputs Forward: Secure market outlets for outputs	Spread risk through products diversification

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Market structure

Features of different market structures

Features	Perfect competition	Imperfect competition
Features	Perfect competition	Monopolistic competition	Oligopoly	Monopoly
Number of sellers	Many small sellers		A few dominant sellers with or without many small sellers	Only one seller
Ease of entre	Free entry		Not easy	No entry
Nature of products	Homogeneous	Heterogeneous	Can be homogeneous or heterogeneous	No close substitutes
Availability of market information to buyers & sellers	Perfect information	Imperfect information
Other features	Price takers (only one price in the market) Does not engage in non-price competition	Price searcher (more than one price in the market)
Other features		Engage in both price and non-price competition	Interdependent in pricing policies Prices tend to be rigid but sometimes a price war may occur Price leadership may exist Non-price competition is common	Engage in both price and nonprice competition

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Sources of monopoly power

Sole ownership of essential resources or techniques required in production

Sole ownership of patents or copyrights

Sole ownership of franchise

Government monopoly

Natural monopoly: A market allows no room for more than one firm to exist as the set-up cost is extremely high, only the largest/the first firm in the market can enjoy the lowest average cost, thus driving competitors out of the market and becoming a natural monopoly.