A level Economics: UK's inflation is due to rise in corporate profit-taking

Figures give fuel to claims that profiteering has played a big part in the UK’s high levels of inflation writes Phillip Inman in The Guardian 


British companies have boosted their profitability, according to the latest official figures, insulating themselves against cost pressures and fuelling claims that profiteering has played a big part in the UK’s inflation story.

In a week when Joe Biden said he was only winning the war against inflation in the US because corporate profits were declining, figures released on Thursday by the Office for National Statistics showed UK business profits increased in the first quarter of 2023.

Manufacturing firms increased their net rate of return to 8.8% in the first quarter, from 8.4% in the fourth quarter of 2022. Services companies, which account for about three-quarters of economic activity, increased their net rate of return to 16.1%, an increase of 0.4 percentage points from the last three months of 2022.

The rate of return is a measure of profitability that shows the margin between operating profits and the cost of assets used to generate those profits. Unions have accused firms of putting up prices by more than the rise in their costs, a trend nicknamed greedflation.

It is a hot topic because the Bank of England has consistently said the small ups and downs registered by the ONS in its calculations of corporate profitability show little evidence of profiteering. It has repeatedly urged workers to restrain wage demands and played down the need to tell companies to restrain price rises.

On the other side of the argument stand a growing number of academics, thinktanks and unions.

The TUC general secretary, Paul Novak, said he was shocked by the ONS figures, which he claimed showed “a culture of entitlement is alive and well” among the large corporations that he said were mostly to blame for higher prices.

Sharon Graham, the head of the Unite union, arguably credited with doing more than anyone in the UK to promote research into corporate profits, said companies were exploiting a crisis.

Philip King, a former government adviser and small business commissioner until 2021, said many small and medium-sized companies would wonder what the fuss was about. He said it was clear from the figures that “companies are maintaining their profitability despite the difficult trading conditions they have faced”, and it was large businesses that would be to blame. These “typically have more flexibility when it comes to increasing prices and cutting costs”, he said.

The International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD) and many leading academics say steady profit margins show businesses are doing better than any other participants in the economy, in particular workers.

An OECD report last month found average profit margins in the UK increased by almost a quarter between the end of 2019 and early 2023. Stefano Scarpetta, a director of the OECD, said it was “somewhat unusual that in a period of slowdown in economic activity we see profit picking up”.

George Dibb, an economist at the IPPR thinktank, said the Bank of England was “plain wrong” to consider steady profit margins a non-story.

On closer inspection the headline average is if anything worse than it first appears. Overall, the net rate of return for all non-financial businesses – a measure that excludes banks and insurance companies but includes North Sea oil and gas firms – increased from 9.8% in the last quarter of 2022 to 9.9% in the first quarter. That shows margins remained consistent through one of the worst winters for cost of living rises and cuts in disposable incomes for several generations.

However, excluding North Sea oil and gas firms, which showed a slump in profitability in the first quarter as energy prices fell from their peaks, dragging down the average, the level of profitability for most firms jumped from 9.6% in the last quarter of 2022 to 10.6% in the first quarter of 2023.

Richard Murphy, a professor of accounting at the University of Sheffield, said low wage rises in most sectors outside financial services meant large companies were probably doing much better than smaller ones.

Murphy said half of all UK company profits were generated by small and medium-sized companies and the other half by a few thousand larger firms.

Another interest rate rise is expected next month and the main reason given by the Bank will be that wages are rising too quickly, not that profits are rising too quickly. It is a stance that is going to become increasingly contentious.

A Level Economics 40: Evaluating Monopolistic Competition

 Short and Long Run Equilibrium in Monopolistic Competition:

Short Run Equilibrium: In the short run, firms in monopolistic competition can earn either economic profits, incur losses, or break even. This situation arises due to product differentiation, which allows firms to have some degree of market power. Here's how the short run equilibrium is achieved:

1. Profitable Firms: Firms that successfully differentiate their products and attract loyal customers may earn economic profits in the short run. These profits act as an incentive for firms to continue producing and expanding their market share.

2. Loss-Making Firms: On the other hand, firms that fail to attract enough customers or face intense competition may incur losses in the short run. Some firms may exit the market if losses become unsustainable.

3. Zero Economic Profit: In the short run, some firms may earn normal profits (zero economic profit), where total revenue equals total cost, including normal returns to all resources. These firms continue to operate but have no economic incentive to expand or exit the market.

Long Run Equilibrium: In the long run, entry and exit of firms occur based on the profitability of the industry. Here's how the long run equilibrium is achieved:

1. Entry and Exit: If some firms are earning economic profits in the short run, it attracts new firms to enter the market to take advantage of the opportunity. This entry increases competition, leading to a decrease in demand for existing firms' products and reducing their market share. Conversely, if firms are facing losses, some may exit the market, reducing competition and increasing the market share for remaining firms.

2. Product Differentiation: In the long run, firms continue to differentiate their products to maintain their market share and attract customers. However, due to entry and exit, they no longer earn economic profits, and price competition keeps their profits at a normal level.

3. Zero Economic Profit in the Long Run: In the long run, firms in monopolistic competition reach a state of zero economic profit (normal profit). Total revenue covers all costs, including opportunity costs of the resources used. Since there is no incentive for further entry or exit, the market stabilizes, and each firm produces at the level where average total cost is minimized.

Evaluation of the Model:

Strengths:

1. Realistic Representation: Monopolistic competition more accurately reflects real-world markets, where product differentiation and branding are common.
2. Variety for Consumers: Product differentiation offers consumers a wider variety of choices and allows firms to cater to diverse preferences.
3. Incentive for Innovation: The pursuit of product differentiation encourages firms to invest in innovation and create new products.

Limitations:

1. Excess Capacity: Firms in monopolistic competition may produce at less than full capacity to maintain product diversity, leading to inefficiencies.
2. Price-Setting Power: While firms have some pricing freedom, they are not price takers like in perfect competition, which may lead to less allocative efficiency.
3. Monopoly and Competition: Monopolistic competition combines elements of both monopoly and competition, which may not fully represent either market structure.

In conclusion, monopolistic competition is a market model that accounts for product differentiation and limited price-setting power of firms. In the short run, firms can earn profits or incur losses, while in the long run, entry and exit lead to zero economic profits and product differentiation. The model offers a more realistic portrayal of real-world markets but comes with some inefficiencies related to excess capacity and imperfect competition. Overall, it serves as a useful framework for understanding markets with differentiated products and imperfect competition.

A Level Economics 37: The Short and Long Run in Perfect Competition

In perfect competition, the short run and long run are crucial timeframes for firms to adjust their production levels and optimize their operations. The short run refers to a period where at least one factor of production remains fixed, while the long run is the timeframe where all factors of production can be adjusted.

Adjustment in the Short Run:

In the short run, firms have limited flexibility to change their production capacity since some factors, like plant size and capital equipment, are fixed. However, they can adjust their output levels by varying variable factors, such as labor and raw materials. If market conditions change, firms can respond in the short run by increasing or decreasing their output to align with demand.

1. If demand increases: Firms experience higher prices due to increased demand. In the short run, they can respond by producing more output with existing fixed resources and higher labor utilization.

2. 
   

3. If demand decreases: Firms face lower prices due to reduced demand. In the short run, they may continue producing at the same level to minimize losses or reduce output slightly, but they cannot fully eliminate the fixed costs.

Adjustment in the Long Run:

In the long run, all factors of production are variable, and firms can fully adjust their production capacity. If firms in the industry are making profits in the short run, new firms are attracted to enter the market. Conversely, if firms are experiencing losses, some may exit the market.

1. Profit in the short run: Existing firms in the industry make economic profits due to high demand and prices. In the long run, these profits signal an incentive for new firms to enter the market, increasing competition.

2. 
   

3. Losses in the short run: Some firms may incur economic losses due to low demand or high costs. In the long run, these losses act as a signal for firms to exit the market, reducing competition.

In the long run, the entry and exit of firms have a significant impact on the industry's supply and demand dynamics. The market price adjusts to the point where all firms earn normal profits (zero economic profit). Normal profits are sufficient to cover all costs, including opportunity costs of the resources used.

Ultimately, in perfect competition, the short run adjustments, such as changes in output levels, are only temporary solutions to respond to changing market conditions. In the long run, firms fully adjust their production levels, and the market reaches a state of equilibrium where all firms earn normal profits and produce at an optimal level based on consumer demand. The long-run equilibrium reflects a state of allocative and productive efficiency, where resources are optimally allocated, and firms operate at their lowest average total cost.

A Level Economics 35: Objectives of Firms

 Firms may have different objectives based on their priorities and the market environment they operate in. Here are explanations with examples of different objectives a firm may pursue:

1. Profit Maximization:

   • 
     
   • Profit maximization is a common objective where firms aim to earn the highest possible profits by maximizing the difference between total revenue and total costs.
   • 
     
   • To calculate the profit maximization point, a firm compares marginal revenue (MR) with marginal cost (MC). Profit is maximized when MR equals MC.
   • 
     

   Example: A software development company may focus on producing high-demand software products at a low cost and selling them at competitive prices to maximize its profits.

2. 
   

3. 
   

4. Revenue Maximization:

   • 
     
   • Revenue maximization involves striving to achieve the highest possible total revenue without necessarily focusing on maximizing profits.
   • 
     
   • The firm aims to sell more units of goods or services, even if it means lowering prices or accepting lower profit margins.
   • 
     
   • Example: A movie theater offers discounted tickets for a limited time, attracting a larger audience. While the profit margin per ticket may be lower, the theater's objective is to maximize total revenue by selling more tickets.

5. 
   

6. Market Share Maximization:

   • 
     
   • Market share maximization refers to the objective of capturing the largest possible market share in the industry.
   • 
     
   • Firms prioritize market share to gain a competitive advantage and influence industry dynamics.
   • 
     

   Example: A smartphone manufacturer may adopt aggressive pricing and marketing strategies to gain a dominant market share, even if it means operating at lower profit margins.

7. 
   

8. Survival:

   • 
     
   • In challenging or competitive markets, a firm's primary objective may be survival, especially during economic downturns or when facing intense competition.
   • 
     
   • The firm's focus is on maintaining its operations and financial stability.

   Example: A small local restaurant may prioritize survival by closely managing costs, optimizing menu offerings, and adapting to changing customer preferences to stay afloat amidst tough competition.

9. 
   

10. Social and Community Objectives:

    • 
      
    • Some firms adopt social and community-oriented objectives to contribute positively to society and the communities they serve.
    • 
      
    • These objectives may include supporting environmental sustainability, philanthropy, or engaging in socially responsible practices.
    • 
      

    Example: A clothing company may commit to using sustainable materials, reducing carbon emissions in its supply chain, and contributing a portion of its profits to support local community initiatives.

11. 
    

12. Innovation and R&D:

    • 
      
    • Some firms prioritize innovation and research and development (R&D) to develop new products, services, or technologies.
    • 
      
    • Such firms aim to stay ahead in the market by continuously introducing innovative offerings.

    Example: A tech company may invest heavily in R&D to develop cutting-edge technologies, leading to the creation of new electronic gadgets with unique features.

13. 
    

14. Customer Satisfaction and Loyalty:

    • 
      
    • Firms may emphasize customer satisfaction and loyalty as key objectives to build long-term relationships with their customers.
    • 
      
    • This can lead to increased customer retention and positive word-of-mouth.

    Example: An online retailer may focus on providing exceptional customer service, hassle-free returns, and personalized recommendations to enhance customer satisfaction and loyalty.

15. 
    

16. Satisficing:

    • 
      
    • Satisficing is an alternative objective where firms seek to achieve satisfactory results or meet specific criteria rather than maximizing profits or revenues.
    • 
      
    • Instead of searching for the absolute best outcome, firms aim to achieve a level of performance that is considered acceptable or sufficient.
    • 
      

    Example: A non-profit organization focuses on providing a certain level of humanitarian aid, even if additional fundraising could provide more resources. The organization satisfices by meeting its predefined aid targets, which align with its mission.

In summary, firms can have various objectives based on their priorities, market conditions, and long-term strategies. While some prioritize profit maximization or revenue growth, others may emphasize market share, social responsibility, survival, innovation, or customer satisfaction. Each objective reflects the firm's unique priorities and considerations in its decision-making process.