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What is economics: Economics is a social science that studies human behavior that how a consumer satisfies his/ her

needs and wants with the help of limited resources. It is actually about how we can make best use of our available resources (optimum utilization). Resources are used to satisfy needs (essentials for survivals) and wants (desires). Basic economic problem Human wants are unlimited because they are multiple and arise again and again on the other hand resources available to satisfy these wants are limited as they have alternative uses. We have to choose between alternatives which mean satisfaction of all the wants is not possible so we have to sacrifice; this sacrifice is known as opportunity cost (the next best alternative foregone). Limitation of resources and unlimited want create basic economic problem of scarcity. Factors of production To produce goods and services we require resources. We call these the factor inputs available in the production process. Economic resources are scarce relative to the infinite needs and wants of people and businesses operating in the economy. It is important to use these resources efficiently in order to maximize the output that can be produced from them. Economists make a distinction between four types of resources land, labour, capital, and entrepreneurs. LAND (natural resources) Land includes all the natural resources available for production. Some nations are endowed with natural resources and exploit this by specializing in the extraction and production of these resources. Only one major resource is for the most part free - the air we breathe. The rest are scarce, because natural resources have alternative uses and it is not possible to satisfy the demands of consumers and producers. Air is classified as a free good since consumption by one person does not reduce the air available for others - a free good does not have an opportunity cost LABOUR (human resource) Labour is the human input into the production process and it involves mental and physical activity to earn some monetary reward. Two important points need to be remembered about labour as a resource: A housewife and a keen gardener both produce goods and services, but they do not get paid for them. They are producing non-marketed output and the output of these people is not included in Gross Domestic Product Not all labour is of the same quality. Some workers are more productive than others because of the education, training and experience they have received Human capital refers to the quality of labour resources, which can be improved through investments in education, training, and health CAPITAL (man made resources) To an economist, capital has several meanings - including the finance raised to operate a business. But normally the term capital means investment in goods that can produce other goods in the future. Capital refers to the machines, roads, factories, schools and office blocks which human beings have produced in order to produce other goods and services. A modern industrialized economy possesses a large amount of capital, and it is continually increasing. Increases to the capital stock of a nation are called investment. Investment is important if the economy is to achieve economic growth in the long run. An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 1

FIXED CAPITAL: Fixed capital includes machinery, plant and equipment, new technology, factories and buildings - all goods designed to increase the productive potential of the economy in future years. We also include the social capital created from Government investment spending, i.e. the building of new schools, universities, hospitals and spending on expanding the national road network. WORKING CAPITAL: Working capital includes stocks of finished and semi-finished goods (components) that will be either consumed in the near or will be made into finished consumer goods. ENTREPRENEURS Entrepreneurs are people who organize other productive resources to make goods and services. Some economists regard entrepreneurs as a specialist form of labour input. Others believe that they deserve recognition as a separate factor of production in their own right. The success and/or failure of a business often depend critically on the quality of entrepreneurship. Example: What resources go into making a car? Focus on the main factor inputs: Labour: Workers employed directly in the car industry; engineers, designers, paint sprayers, testers, management staff, transport & distribution workers etc Land: Natural resources used in manufacturer, land for plant and equipment Capital: Fixed capital: machinery, technology, buildings + Working capital: i.e. stocks of raw materials and components Entrepreneurship (sometimes seen as a separate factor): management, risk-taker

Choices and opportunity cost


There is a famous saying in economics that "there is no such thing as a free lunch". Even if we are not asked to pay for consuming a good or a service, scarce resources are used up in the production of it and there must be some opportunity cost involved - the next best alternative that might have been produced using those resources. Opportunity cost measures the cost of any economic choice in terms of the next best alternative foregone

Point to remember
When we are considering the opportunity costs of decisions we make, we must use the highest-valued alternative that has had to be sacrificed for the option we have chosen. Many choices involve more than one alternative.

Production Possibilities Frontier (PPF)


The Production Possibilities Frontier (PPF) or production possibility curve (PPC) shows the maximal combinations of two goods that can be produced during a specific time period given fixed resources and technology and making full and efficiency use of available factor resources. A PPF is normally drawn as concave to the origin because the extra output resulting from allocating more resources to one particular good may fall. This is known as the law of diminishing returns and can occur because factor resources are not perfectly mobile between different uses, for example, re-allocating capital and labour resources from one industry to another may require re-training, added to a cost in terms of time and also the financial cost of moving resources to their new use.

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An example of a conventional PPF is shown in the diagram above which shows potential output of DVD players and MP3 players from a given stock of labour and capital. Combinations of the two goods that lie within the PPF are feasible but show an output that under-utilises existing resources or where resources are being used inefficiently. Combinations of the two goods that lie on the PPF are feasible and can be produced using all available factor inputs efficiently. In the PPF diagram above, the combination of output shown by point E is unattainable given current resources and the productivity of the available factor inputs Shifts in the PPF The production possibility frontier will shift when: (a) There are improvements in productivity and efficiency (perhaps because of the introduction of new technology or advances in the techniques of production) (b) More factor resources are exploited (perhaps due to an increase in the available workforce or a rise in the amount of capital equipment available for businesses to use) In our example illustrated in the second diagram below we see the effects of a change in the state of technology in supplying MP3 players which causes an outward shift in the PPF. With the same resources allocated to DVD players, a greater output of MP3 players is possible. The real cost of MP3 players will fall there has been a change in the opportunity cost

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Approaches to the fundamental economic problem


BASIC ECONOMIC DECISIONS 1. What to produce? 2. How should production be organized? 3. For whom should production take place?

Economics systems
FREE MARKET ECONOMIES A free market economy is one where economic decisions are made through the free market mechanism. The forces of market demand and supply, without any government intervention, determine how resources are allocated. This is known as the working of the price mechanism. The basics of this are covered in the theories of demand and supply later on in this revision guide. What to produce is decided upon by the profitability for a particular product. When demand for a product is high, the price rises and this raises the profitability of selling in the market High prices and high profits provide the signal for firms to expand production. Supply from producers responds to consumer wants and needs expressed through the price mechanism The consumer is said to be sovereign - their "economic votes" determine how resources are allocated

COMMAND ECONOMIES A command economy is one where all key economic decisions are made by the government (or state). The government decides what to produce, how it is to be produced, and how it is to be allocated to consumers. This involves a great deal of economy planning by the state. The price mechanism has no active role in a pure command economy since market prices are rarely used. By state planning, goods and services can be produced to satisfy the needs of all the citizens of a country, not just those who have the money to pay for goods. Over the last decade, many former planned economies have attempted to bring market forces into their economy. Comparison of Command and Free Market Economy: Free Market Advantages of the free market recourses are allocated by the market forces and the price mechanism (called the invisible hand by the Adam Smith): there is no Government intervention the profit motive provides an incentive to reduce costs and be innovative the free market maximizes community surplus if there are no failures and imperfections Disadvantages of the free market See market failure and imperfections e.g. public goods merit goods externalities instability

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Command or planned economy Advantages of the Command or planned economy Disadvantages of the Command or planned economy the Government can influence the distribution of requires an enormous amount of information income to make it more equal (and almost inevitability there will be information overload leading to inefficiency); the Government can determine which goods are often bureaucratic supplied (e.g. it can prevent the production of sociality undesirable goods) no incentive for the individuals are firms to be innovative lack of the profit motive; goods are often poor quality and usually limited choice. liable to lead to allocative productive inefficiency due to lack of competition and no profit motive.

MIXED ECONOMIES A mixed economy is a mixture of a pure free-enterprise market economy and a command economy. Nearly every country in the world operates a mixed economy although the "mix" can change. There is a private sector and a public sector in the economy In recent years many command economies have become mixed economies. Examples include countries that were part of the former Soviet Union. To become a mixed economy, the role of the market and the private sector of the economy must be increased. This can be done in a variety of ways - listed below: Privatization of state industries De-regulation of markets promoting increased competition through the entry of new firms A gradual ending of state subsidies Encouraging foreign investment into the economy Advantages of mixed economy:

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LEGAL STRUCTURE OF BUSINESS ORGANIZATIONS Sole Trader A sole trader is a one-person business, commonly found in trades where only small amounts of finance are required to set up and where there are very few advantages to the existence of larger organisations (e.g. hairdressing, newsagents, and market traders). Sole traders often employ waged employees, but they alone have to provide all the finance (often savings and bank loans) and bear all the risks of the business venture. In return, they have full control of the business and enjoy all the profits. A sole trader faces unlimited liability for his/her debts and it is referred to as an unincorporated business this means that there is no legal difference between the business and the owner. Advantages of being Sole Trader:

Disadvantages of being Sole Trader:

Partnership To overcome many of the problems of a sole trader, a partnership may be formed. A partnership is an association of individuals and generally there will be between 2 and 20 partners. Each partner is responsible for the debts of the partnership and therefore you would need to choose your partners carefully and draw up an agreement on the responsibilities and rights of each partner (known as a Deed of Partnership or The Articles of Partnership). The most common examples of a partnership are doctors surgeries, veterinarians, accountants, solicitors and dentists. As stated earlier, most partners in a partnership face unlimited liability for their debts. The only exception is in a Limited Partnership. This is where a partnership may wish to raise additional finance, but does not wish to take on any new active partners. An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 6

To overcome this problem, the partnership may take on as many Sleeping (or Silent) Partners as they wish these people will provide finance for the business to use, but will not have any input into how the business is run. In other words, they have purely put the money into the business as an investment. These Sleeping Partners face limited liability for the debts of the partnership. A partnership, just like a sole trader, is an unincorporated business. Advantages of being Partnership:

Disadvantages of being Partnership:

Private Limited Company This is a type of joint-stock company (that is, it is an incorporated business where the business has a separate legal identity from the owners). Often private limited companies are small, family run businesses which are owned by shareholders. Each shareholder in a private limited company MUST be a part of the business and under no circumstances can any shares be sold to members of the general public. Each share entitles the owner to 1 vote at the companys Annual General Meeting (AGM.) and also to a share of the companys profit at the end of the financial year (a dividend). Each shareholder has limited liability for the companys debts and can, therefore, only lose the value of their investment in the company. A company is run by a Board of Directors (who are elected by the shareholders) and a Chairman Heads this. Before a company can be formed, a number of legal documents must be completed most important are the Memorandum of association and the Articles of Association. These cover details such as: The objectives of the business Its headquarters and registered office The amount of capital to be raised from the sale of shares Details concerning meetings within the business The arrangements for auditing the accounts of the business.

When these are completed, they are sent to the Registrar of Companies, who will then issue the business with a Certificate of Incorporation, which allows the business to trade as a Private Limited Company. The companys name must finish with the word Limited and it must raise less than 50,000 of share capital. It can be very difficult for a shareholder in a private limited company to sell their shares, since a buyer must be found within the framework of the company.

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Public Limited Company (PLC) This is the other, much larger, type of joint-stock company and, just like a private limited company; a PLC is an incorporated business, is run by the Board of Directors on behalf of the shareholders and has an AGM. At which shareholders vote on certain key issues relating to the company. The main difference between a PLC and a private limited company is that a PLC can sell its shares on the Stock Exchange to members of the general public and can, therefore, raise significantly more finance than a private limited company. If a private limited company wishes to become a PLC, then it must change its Memorandum and Articles of Association and re-submit them to the Registrar of Companies. If the company is considered to have acted legally and for the best interests of its shareholders, then it will be issued with a new Certificate of Incorporation and also with a Certificate of Trading, which will allow it to sell its shares on the Stock Exchange. The price of the shares will then fluctuate according to investors perceptions of the PLC. It is often the case with a PLC that the owners of the company (shareholders) will wish the PLC to make as much profit as possible, so that the shareholders will receive a very handsome dividend per share. However, the Board of Directors and the management will often wish to devote some of the PLCs resources to growth and diversification (such as the introduction of new products) and this will clash with the shareholders desire for maximum profits. This is known as the divorce of ownership and control. The PLC has to publish its annual accounts (known as disclosure of accounts) and therefore is extremely vulnerable to investors and bankers perceptions about its progress and success. Following on from this, a PLC is also at risk from a takeover from an outside body, if they manage to accumulate over 50% of the shares in the PLC. Similarities between private and public companies:

Differences between private and public companies:

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Growth (integration)
In long term each and every business tries to expand its business activity. Sometimes by diversifying their operations and sometimes by growing in size. The basic purpose of growth is to achieve economies of scales so that risk of failure can e reduced. Internal growth: (Often referred to as organic growth) refers to a situation where a business increases its size through investing in its existing product range, or by developing new products. This will normally be financed through the use of retained profits (from previous trading years), bank loans or, if the business is a PLC, through the issue of shares. This is a slower and safer method of expansion than external growth. External growth: Involves much greater sums of money and takes place through the use of mergers and takeovers (often known as growth through amalgamation, or simply integration). Regardless of the method of growth, there are several reasons why firms wish to grow: To achieve economies of scale and see the average cost of production decline. To achieve a greater market share. To satisfy the ego of the businessman. To achieve security through becoming more diversified. To survive in an increasingly competitive market How to Growth

Merges Mergers

Takeovers

Franchise

Joint ventures

Where two or more than two businesses merge into one entity and start their operations under new name, eliminating the previous entity e.g. standard chartered, ANZ Gridleys (when they are merged so they are known as standard chartered Grind leys) Why to merge? To achieve economies of scale. To avoid extra operational cost To compete To increase market share

Disadvantages Established entity will be eliminated and this can hurt grand loyalty. Conflict of interest between the managements of merged businesses. Diseconomies of scales

Take Over
A growth technique where a business buys out more than 50% shares of any other business. It means now all the decision making powers are divorced to the business which has bought the other one e.g. standard chartered taking over union bank An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 9

Why to takeover? To achieve economies of scales To eliminate competition To control the management of related industry or business so that core business can be supported more efficiently. Disadvantages Diseconomies of scale It can create private monopolies which can be harmful for the society because they can exploit the consumer by charging very high prices. Joint Ventures A growth technique where two or more business join hands together for a specific project or specific period of time under their own entities and after the completion of that project they will disperse and will resume their own activities e.g. Bata and Hush puppies, Silt route. Advantages of Joint Venture Small business can take large investment projects by shaking hands Risk can be shared and chances of failure reduce. More capital can be generated and cost will also split on more than one business. Pooling of expertise which can provide competition edge.

Disadvantages of Joint Venture Franchise It is growth technique where an established business sells license to some one that his name can be used. The basic idea of Franchise is to grow your brand name without further investment. Franchise can sell his name to franchisee for: To sell To produce To produce and sell (Nike) (SAGA sports, they can only produce and cannot sell in retail) (Mc Donald) Conflict of interest may arise between different stake holders. It can be to manage because each and every business has its unique way of operating. Less profit can be there because profits will divide on more businesses.

Advantages to Franchiser More revenue without any further investments. Increase bargaining power with every next new unit. Economies of scales

Disadvantages to Franchiser quality. Bad repute or negative good will can be there if franchise will not be able to maintain the An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 10

Very high training and R&D cost. Loss of revenues

Advantages to Franchisee Less risk of failure because franchisee is operation with an established brand name. More profits because of economies of scales. Advertisement and Training cost is very low.

Disadvantages to Franchisee Low of revenue has to give a limited amount of percentage to franchiser. Very high initial cost. Dependency on franchisee because no flexibility of policies or innovation is there. INTEGRATION (Growth)

HORIZONTAL Same product and same stage (Polka has been taken over by walls) Vertical forward 1 2 3

VERTICAL same product Different stage Vertical Backward 1 2 3

Integration with the user of product or raw material (Shoe manufacturer integrating with shoe retailer)

integration with supplier (shoe manufacturer integrating with leather processing business)

Advantages of growth: (Economies of scale) As a business grows in size and produces more units of output, then it will aim to experience falling average costs of production (i.e. on average, each unit of output costs less to produce). This is known as benefiting from economies of scale. In other words, the business is becoming more efficient in its use of its inputs to produce a given level of output. Internal economies of scale Technical This refers to the fact that the use of automated equipment and machinery to produce output is far more cost-effective than using labour, since the machinery can be used 24 hours a day, with no breaks and with a constant level of output per hour. Purchasing Larger businesses are more likely to be able to bulk-buy their supplies and their raw materials, and therefore secure their supplies at a far lower cost per unit than a smaller business.

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Financial Banks and other financial institutions are more likely to offer a lower rate of interest on a loan repayment to a larger business than to a smaller business, since the larger business represents less of a risk because it is more financially secure. Managerial Larger businesses are more likely to be able to afford to employ managers who are specialists in a particular field. These managers can therefore devote all their time to specializing in one particular field (resulting in higher levels of efficiency and hopefully falling average costs). Smaller businesses will often employ managers who have to perform a variety of tasks and therefore cannot specialize in a single area of the business. External economies of scale Labour A large pool of available labour in a particular area of the country which has been trained at a local college, or even at a rival business, will possess specialized skills which will be useful to the whole industry, rather than simply to just one business. Joint ventures Two or more businesses may decide to join forces (perhaps for R&D) in order to spread the costs and the risks of developing a new product or manufacturing process. Support services A wide range of commercial and support services often cluster together in a certain area near a number of rival businesses (e.g. waste disposal, cleaning, component suppliers, distribution, etc). Clearly this benefits all the businesses in the area, rather than just one of them. Problems of Growth (disadvantages) However, it is also possible that as a business grows in size and produces more units of output, then it will actually experience rising average costs of production (i.e. on average, each unit of output costs more to produce). Rapid and unexpected growth can lead to a host of problems for businesses. Probably the most common problem is the effect that the growth has on the companys finances specifically upon the liquidity and gearing of the company. Extra expenses and increased long-term liabilities (such as loans and mortgages) may reduce the liquidity and increase the gearing levels of the company and leave it dangerously close to insolvency. It may simply be the case that the managers cannot cope with the extra responsibilities and workloads that they are faced with this could lead to a rapidly expanding workforce, with the problems of recruitment, training and lengthy communication channels that this will inevitably lead to. It is also possible that the company may become inefficient and it may experience diseconomies of scale (rising average costs). This could lead to a significant fall in profits, which in turn could persuade shareholders to sell their shares this would result in a falling share price. A major problem that a PLC can experience as it grows is the divorce of ownership and control. This refers to the fact that the owners of a PLC (shareholders) are usually interested in maximizing the companys profits and, therefore, their own dividend payments. However, the control of the company is in the hands of the management and the Directors. They too want the company to be profitable, but would also like some of the companys resources and money to be invested into new products and new markets. This, clearly, reduces the short-term profits of the company and, therefore, also reduces the dividend payments to shareholders.

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Size of the business


How to measure the size of Business? Small scale Medium size Large size

1) Capital employed The total resources invested in to the business from all the sources 2) Number of workers employed 3) Market share Number of customer using a product of a specific business out of the total market is known as market share and it is expressed in percentage 4) Turn over /revenue/sales 5) Profits ( TR TC ) Why some businesses remain small? Lack of resources because small scale business is normally owned by a sole owner and the main source of finance is personal savings or informal loans. Lack of visions, ambitions, or targets. Lack of promotional activities (advertisement, free samples) Lack of research and development activities. Lack of personality trait, not confident enough to expand business or open new branches.

How small scale businesses can compete with the large scale businesses? By creating Niche Market: A small segment of specialized market which is ignored by the large scale businesses or large scale businesses is not aware of the overall potential of that market. But the problem with niche market is that large scale businesses can exploit and take over the market any time. Because they have huge brand following. Personal services can be provided to the customers so that satisfaction level can be Diversification of activities: (variety of products) An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 13

maximized.

Govt grants, Aid and subsidies can reduce costs

Why large scale businesses are more successful? More resources are available as they can attract new investor and can also borrow from financial institutions. Economies of scales bring the average cost very low so their profit margins are very high.

They can afford to conduct research and development which fives these businesses competitive edge. Due to excessive resources they can eliminate competition from the market by taking over the other businesses. influence. They can have favorable lows by the Government by using their international, political

How Multi National companies are beneficial for any country? MNCs bring huge amount FDI (foreign direct investment) which can be used to improve BOP and country can import machinery which is essential for economic growth. Transfer of skills and technology because normally MNCs use local work force and to make them more efficient and productive they provide them training which is of international standards. Due to competition quality goods can be available at low or competitive prices which will increase the standard of living. Domestic producers will also become more efficient s now they have to compete international standards and quality. So domestic producers will also plough back the puffers and try to increase their productivity. As MNCs operate on very large scale so job opportunities will be available which will reduce unemployment level and increase standard of living. MNCs can also increase in economic growth level. As there will be an increase in economic activity in that specific country. How MNCs can be harmful for any country? Discouragement to domestic producers because they cannot afford to produce higher quality goods due to lack of finance and modern machinery and equipment. In long term, MNCs can form monopolies by taking over domestic producers or by kicking them out of the business. In long run MNCs can cause very high unemployment rate as small scale domestic producers will go out of the business. An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 14

country.

Adverse BOP can be there because in long term there will be an out flow of profit from the Political influence can be there so that they can have favorable legislation.

Business Sectors Public sector Private sector

Where all the productive resources are owned and Where all the productive resources are owned and controlled by Government and the basic purpose controlled by private individuals and there is no of public sector is not to earn profit but to provide social Government interventions accept the legislative process. services to each and every member of the society without any discrimination. Incorporated Unincorporated (Limited) (Unlimited) Corporations Nationalised Industries - Private limited - Sole traders (Wapda, wasa) (UBL ,HBL in 1972) - Public limited - Partnership Why Public Sector is important/ what is the significance of public sector? Public sector basically represents public and protects interest of the public and it is the responsibility of the public sector to provide the basic utilities and social services to each and every member of the society without any discrimination. Public sector produces public and merit goods which is essential for the community as a whole. Public goods are those which are provided free of cost to each and every one. Public goods carry three features a. Non excludability b. Non exhaustibility (existence) c. Non rivalry E.g., defense, street lights, public parks, roads. Merits goods are those goods which are provided at subsidized rates and the basic purpose is to provide the society equal opportunities so that every member can become more efficient and productive e.g. health and education. Public sector is also responsible for the protection of society so that private sector can not exploit the society by producing demerit or illegal goods. Public sector also works as a watch dog and monitors the activities of private sector so public interests can be protected (Demerit goods are not illegal but harmful for the society) Significance of Private Sector Private sector works for profits and to maximize their profits private sectors firm try to produce variety of high quality goods. It is responsible for the improvement in living standards a consumers sovereignty. Private sector produces only those items where profits are available but in search of profit research and development is conducted which can be beneficial for the society. It also provides job opportunities and is also responsible foreign exchange through exports so private sector is the main element quality, variety, and innovations. Private and public sector objectives An Insight to Economics AZAR ANJUM RIAZ (0321-4455386) 15

Private sector Private sector objectives will often differ considerably from objectives set in the public sector. Profit maximisation is often quoted as the over-riding objective for businesses in the private sector. This will involve trying to produce at the point where there is the maximum difference between the firms total revenue and its total cost - resulting in large dividend payments for the shareholders. However, it is far more likely that businesses will aim to profit satisfy rather than profit maximise (that is, they will aim to earn a satisfactory level of profits to keep shareholders content, and then use the remaining resources to pursue other objectives such as diversification and growth). Another objective in the private sector, for a rapidly growing business, may well be to maximise sales (or sales revenue) and so increase their market share in order to gain a competitive advantage.Many businesses set objectives to improve their image and to appear more socially responsible and environmentally friendly this is often achieved through strategies of recycling materials, sponsoring local events and strictly adhering to all employee legislation (e.g. pay levels, Health & Safety, discrimination, etc.). Public sector Public sector objectives have, traditionally, been centered on providing a public service, rather than make a profit. This regularly led to loss-making organisations being subsidized by the government, and complacency crept in with regards to customer service, quality levels, and response times. The remaining public sector organisations were told to run in a more cost-efficient manner and to improve the quality of their services to c consumers. Performance targets were set for many Local Health Authorities, Local Education Authorities, and council services in an attempt to make them more accountable, to reduce their costs, and to improve the quality of their output. Short-term and long-term objectives Short-term objectives will often differ from long-term objectives, especially if the business is experiencing poor financial performance at present. A short-term objective may be to consolidate, or even simply to survive the difficult trading conditions that it is experiencing. Once this has been achieved and the business has stabilised its performance, then it may well look to achieve its long-term objective of diversification into new products and new markets, or growth through amalgamation.

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