1st midterm Flashcards
PPF
production possibility frontier/ curve
market
any
situation in which the buyer and
seller communicate with each other
for the purpose of exchange.
Market demand
is the total amount of the product that consumers are willing and able to purchase at a particular price over a given period of time.
Factors influencing demand includes
* Price of the product •Price of other products •Household income •Tastes •Advertising
Movement along the demand curve is the result of…
a rise or fall in the price
of the product itself.
Shift upwards and to the right (in the demand curve) Change in conditions of demand
•Rise in price of substitute •Fall in price of complement •Rise in real income (normal product) •Fall in real income (inferior product) •Change of tastes in favor of product •Rise in advertising expenditure
Shift downwards and to left (in the demand curve) Change in conditions of the demand
Fall in price of substitute •Rise in price of complement •Fall in real income (normal product) •Rise in real income (inferior product) •Change of tastes against product •Fall in advertising expenditure
Demand function:
Qx = F (PX , PO, Y , T , AX
Depends upon ( = F) PX - own price of X PO - price of other products Y - real household income T - tastes of consumers AX - advertising expenditure on X
Market supply
is the total amount of the product that producers are willing and able to provide at a particular price over a given period of time.
Factors influencing supply
include:
- Price of the product
- Price of other products
- Costs of production
- Tastes of producers
- Tax on product
- Subsidy on product
Movement along the supply curve is a result of
a rise or fall in the price of the product.
increase of supply
Shift downwards and to the right (in supply curve)
Change in conditions of supply:
- Fall in price of substitute in the production
- Rise in price of complement in production
- Fall in costs of production
- Change of tastes of producers in favor of product
- Tax reduction
- Subsidy increase etc
Decrease in supply
Shift upwards and to the left Change in conditions of supply
- Rise in price of substitute in the production
- Fall in price of complementin production
- Rise in costs of production
- Change of tastes of producers against product
- Tax increase
- Subsidy decrease
Supply function
Qx = F (PX , PO, C, Tn, TX ,TP . . .)
PX - price of product X PO - price of other products C - costs of production Tn - technology TX - tax rates (subsidy is negative tax) TP - Tastes of producers
market equilibrium
Equilibrium price relates to the price at which the quantity demanded equals the quantity supplied.
Market economy:
resources allocated through the price mechanism, with
market prices being determined by the forces of demand and supply.
Planned economy:
the government makes the decisions about what is
produced, how resources are allocated and how the finished products
are distributed.
Mixed economy:
contains features of both the market and planned economic systems, with the government intervening in various ways to influence market prices and resource allocation.
Advantages of market economy:
- Prices act as ‘signals’ to both consumers and producers
- Profits aid resource allocation
- Direct resources to the most profitable activities
- Reward risk-taking
- Encourage productive efficiency (minimum costs)
- Provide resources
Disadvantages of market system:
•Those with the highest incomes have most ‘money votes’
•Competition may be imperfect, so firms may gain ‘market power’ (e.g.
monopoly) and so limit consumer choice
•Externalities: some costs or benefits to society may not be reflected in
the market system as costs or benefits to private firms or individuals
Advantages of planned economy:
•Careful planning can avoid duplication and the waste of scarce
resources
•Planned economies are often claimed to have less income inequalities
since the state owns and controls factors of production
•Excess demand need not result in price rises since prices of product
are controlled by the state
Disadvantages of planned economy:
•Planning authorities may misjudge consumer preferences
•Absence of profit and other incentives may reduce incentives to work
harder and to take risks
•State control of production may mean less competition and therefore
more inefficiencies
•State bureaucracy grows to plan and control production
mixed economy:
Use both markets and government intervention to allocate resources
Government interventions in the economy:
- direct (public sector)
- indirect (e.g. tax, regulations)
QD
quantity demanded
ARC
mid-point elasticity
Elasticity
Measures the responsiveness of the quantity demanded (QD)
of a product to a change in its own price (ARC: mid-point elasticity)
10% decrease in quantity/ 30% increase in price= (…demand)
INELASTIC DEMAND
Perfectly inelastic demand -
increase in price has no effect on quantity (0)
Perfectly elastic demand -
a firm cannot change the price at all ( ∞)
PED
price elasticity of demand
total revenue=
price times the quantity
elastic or inelastic:
Price goes up, revenue goes up
inelastic
Elastic or inelastic:
price goes up, TR goes down
elastic
CED
cross elasticity of demand
cross elasticity of demand
Measures the responsiveness of the quantity demanded (QD) of X to a
change in the price of Y
the equation to CED?
percentage change in quantity demanded of good A/
percentage change in price of B
IED
income elasticity of demand
income elasticity of demand -
Measures the responsiveness of the quantity demanded (QD) of X to a
change in household or national income.
The formula of IED =?
Percentage change in quantity demanded/Percentage change in income
What does it mean if IED is positive or negative?
Positive: normal goods
Negative: Inferior goods
IED = 1
unitary IED
IED < 1
inelastic IED
IED > 1
elastic IED
Total utility =
Total satisfaction obtained from all the units of a particular product consumed over a period of time.
Marginal utility =
Addition to total utility derived from the consumption of one more unit of the product.
Law of diminishing marginal utility =
The more an individual has of a product, the less additional utility will be gained from each extra unit consumed.
TP
Total product
Total product
This is the total output that the firm produces over a given period of time as the number of workers employed is varied
AP
Average product
Average product
The average product of labour represents the output per worker.
MP
Marginal product
Marginal product
The marginal product is the extra output obtained from the employment of one extra worker.
Law of diminishing returns:
In the short run, in which at least one factor of production is fixed, as a firm employs more of the variable factor, it will eventually experience diminishing returns to the variable factor.
Increasing returns:
output rises more than in proportion to the variable factor
Diminishing returns:
output rises less than in proportion to the variable factor
Fixed costs
- Also called overhead or unavoidable costs.
- Do not vary with output.
- Include rent paid on the premises, rates, interest payments on loans and hire purchase repayments.
Variable costs
•Include raw materials, wages of the operative staff and the cost of
fuel. When no output is produced, no variable costs are incurred.
•Also called direct or avoidable costs.
•In the long run, all the factors of production are variable, and so all
costs are variable.
•Do vary with output.
ATC
Average Total Cost
Total costs:
C = TFC + TVC
Average Total Cost:
ATC = AFC + AVC
Marginal Cost:
is additional to total cost from producing last unit of output
Marginal costs are
addition to total cost from producing last unit of
output
In the long run all the factors of production are…
variable.
LRAC
The long-run average cost
LRAC represents…
the lowest cost of producing different levels of output
when all factors can be varied.
Technical economies: relate to the
increase in size of the plant or
production unit
Non-technical economies: relate to the
increase in size of the enterprise as a whole
economies of scope
Reduction in average costs through changing the mix of production
Sources
Reduction in average costs through changing the mix of production
Sources include selecting a product mix that:
•Can use joint inputs (e.g. common management, marketing etc.)
even if the products are unrelated
•Involves products which are complements in production (cars and
trucks, teaching and research)
•Involves by-products that can be used constructively (e.g. heat
from one production process used as energy in another)
PES
price elasticity of supply
price elasticity of supply:
A measure of responsiveness of quantity supplied of X to a change in its own price
Formula of PES:
percentage change in quantity sypplied/ percentage change in price
Factors affecting the PES:
- Mobility of the factors of production
- The time period under consideration
- The willingness of the supplier to take risks.
- Natural constraints on production
Advantages of sole traider:
- Only a small amount of capital to start up
- No need for elaborate legal requirements
- Keeps all profits so strong incentive
- Can make decisions quickly, so flexible
- In sole charge so clear who makes the decisions
Disadvantages of sole traider:
- Lack of capital can limit expansion
- May fail to benefit from economies of scale
- Liability unlimited so personal wealth at risk
- Lack of innovative ideas for expansion because there is only one owner
- Long hours and lack of continuity should the owner not be able to carry on the business
Advantages of ordinary partnership:
- Easy and cheap to set up
- Financial base is greater than for sole trader
- Costs, risks and responsibilities can be shared
- Privacy – no requirement to publish full financial details, which need only be declared to the income tax and VAT authorities
- Unlike a limited company, a partnership cannot be taken over against its will by another partnership
Disadvantages of ordinary partnership
- Unlimited liability
- Capital base being small, limits expansion
- Profits shared and each partner liable for debts, even if not responsible
- Decisions of one partner are binding on all partners
- Lack of continuity – if a partner dies, resigns or is bankrupt, the partnership is automatically dissolved
Advantages of private limited company:
- Limited liability
- Owners keep control and choose the shareholders
- Has its own legal identity so that the survival of the company does not depend on the personal circumstances of its shareholders
- Greater privacy – accounts need only be published in summarised form
Disadvantages of private limited company:
- Shares cannot be sold on the open market – so more difficult for investors to get money back
- Difficult to raise much money as shares cannot be sold to the general public
- There is a limit to the amount of capital that can be raised from friends and family
- Unless the founders own the majority of shares, they may lose control over the business
Advantages of public limited / joint-stock company:
- Limited liability
- Survival does not depend on personal issues of its shareholders
- Cash can be raised as investors know they can sell shares bought
- Economies of scale as can specialize (separate departments etc.)
- Company has a separate legal existence from its owners
Disadvantages of public limited/ joint-stock company:
- Auditor must independently check accounts
- Legal formalities make it costly to set up
- Takeover bids as shares are openly traded
- Separation of ownership from control
- Company often large and bureaucratic
- Activities closely controlled by company law
- Real performance may not always be reflected in the price of its shares
what are the business maximizing objectives?
- Profit maximization
- Sales revenue maximization
- Constrained sales/ revenue maximization
- Growth maximization
what are the business non-maximizing objectives?
- Coalitions
- Stakeholder approach
- Satisficing
what are the business non-maximizing objectives?
- Coalitions
- Stakeholder approach
- Satisficing
MBO
non-maximization objective: satisficing
characteristics of product introduction stage:
- High failure rate
- Little competition
- Frequent modification
- Make looses
Strategies of of introduction stage of the product:
- Create product awarness
- ‘Skim’ pricing or penetration pricing
- Shake - out policy -quickly drop out unsuccessful products
Characteristics of growth stage of the product:
- More competitors
- Raising sales
- Possibly acquired by larger company
Strategies of growth stage of the product:
- Promote brand image
- Acquire outlets
- Obtain economies of scale
Characteristc of maturity stage of the product:
- Sales increase at reduced rate
- Product line widened
- Price falls as market share is lost
- Difficult for new entrants
- Marginal producers dropout
strategies of maturity stage of the product:
- Encourage repeat buys
- Seek new customers by repositioning and brand extension strategies
- Seek to hold or increase market share by greater efficiency
- Use price discounting to hold or win marfket share
- Hold on to distributors
Characteristics of decline stage of the product:
- Falling industry sales
- Falling product sales
- Some producers abandon market
- Falling profits
Strategies of decline stage of the product:
- Strict cost control
- ‘Run out’ sales promotion with low price to get rid of stocks prior to introduction of replacement
- Higher prices charged to fewer, but still loyal customers
SME
A small- to mid-size enterprise
A small- to mid-size enterprise
is a business with revenues, assets, or numbers of employees that fall below a certain level
Neglect of small firms
•Large firms enjoyed economies of scale
•Large firms stimulated more innovation
•Large firms increase competitiveness in world markets
•Government policies usually designed to stimulate growth of large
firms
Small firm survival
- Supply small (niche) market
- Provide personal or more flexible service
- Give entrepreneurs freedom/independence
- Avoid problems of growth
- Benefit from government supports
Renewed interests in small firms
•Large firms often grew through mergers, not from internal growth
and economies of scale.
•Small firms more innovative
•Small firms are important as creators of employment
•Small firms often exported a higher percentage of turnover
Problems facing SMEs
- Relationship with banks
- Debt structure
- Lack of training
- Low turnover and cash flow
- Government regulations and paperwork
measures to help small firms
SME support programs •Small Firms Loan Guarantee Scheme •Enterprise Investment Scheme Alternative Investment Market (AIM) Tax allowances Enterprise grants Small Business Service (SBS) EU funding
Reasons of firm growth:
- Cost savings
- Diversification of product
- Diversification of market
- Market power
- Risk reduction
Methods of firm growth:
- Organic growth
- Franchising
- Licensing
- Mergers
- Takeovers (or Acquisitions)
- Joint Ventures/Alliances
Types of mergers:
pes •Horizontal integration •Vertical integration (backward/ forward) •Conglomerate integration •Lateral integration
why mergers or acquisitions happen?
- Value discrepancy hypothesis
- Valuation ratio hypothesis
- Market power theory
- Economies of scale theory
- Managerial theories
perfect competition
Large number of small firms Each is a ‘price taker’ Large number of buyers Perfect information Homogeneous (identical) product Freedom of entry and exit
In perfect competition demand equals to:
AR=MR=P
In perfect competition supply of firm equals to
MC
All firms should produce for profit maximizing a quantity of products:
MR=MC
TC in perfect competition:
quantity of produced product times AVC at this point
in perfect competition profit is:
TR-TC
pure monopoly:
single firm is the industry
non-pure monopoly:
more than 25% of industry output in the hands of a firm or
group of linked firms
Momopoly characterised by barriers to entry:
- Economies of scale are substantial with a high level of output required to minimise average cost
- Sole ownership of a natural resource
- Intellectual property rights via a patent or copyright giving the firm the sole right to produce a particular good or service
- Whereas in perfect competition there are many sellers of an identical product, with a ‘pure’ monopoly there is a single seller of a product for which there is no close substitute
- Legal monopoly created by the state
disadvantages of monopoly:
- A monopolist may reduce the output and increase the price above that charged by firms in a perfectly competitive market.
- Monopolies are able to earn above normal profit in the long run because of barriers to entry.
- Such excess profit represents a redistribution of income from the consumer to the producer which can be criticized on equity grounds.
- Barriers to entry means that monopolies face less pressure from competition so that average costs may be higher than they need be and/or quality lower.
In monopoly Supply =
MC
monopolistic competition:
As with perfect competition there are a large number of firms in the market and there is freedom of entry. Unlike perfect competition each firm produces goods and services which are slightly different from those of their competitors
•The existence of such product differentiation means that firms have a certain degree of monopoly power, so that if they raise their price they do not lose all of their customers, since some consumers prefer their (differentiated) product, even at a higher price
What are the characteristics Oligopoly?
- High barriers to entry
- Price making power by companies
- Interdependence of firms
- Products are differentiated
Three possible strategic reactions in oligopoly theory
- Firm assumes that its rivals will not react to changes in its strategy
- Firm assumes that rivals will react to changes in its strategy by using their past experience
- Firm will try to assess future reactions of its rivals by identifying the best possible move the opposition could make to changes in its strategies
Informal methods of collusion in oligopoly:
- Dominant-firm leadership
- Barometric-firm leadership
- Collusive-price leadership
Objectives of collusion in oligopoly:
•Joint profit maximization
Formal methods of collusion in oligopoly:
•Cartels
MRP
Marginal revenue product
MRP =
MPP x price
MPP
marginal physical product, i.e. the extra output produced by
the last person employed.
ARP
The average revenue product of labour
ARP=
APP times price
supplie of labour is equal to
AC=MC
The demand of labour is equal to
marginal revenue product of labour
equation of elasticity of demand per labour
% change in quantity of labour demanded/
% change in price of labour
PED
Price Elasticity of Demand
Elasticity of demand for labour is influenced by:
- PED of product produced by labour
- Proportion of total production costs accounted for by labour
- Ease with which other factors of production can be substituted for labour
Equation of elasticity of supply for labour
% change in quantity of labour supplied
% change in price of labour
Elasticity of supply for labour is influenced by:
- Degree to which labour is mobile, both geographically and occupationally
- Time period in question
The total supply of labour to a market depends on the:
- price of labour (i.e. the wage rate)
- size of the population
- age composition of the population
- labour force participation rate
- occupational and geographical distribution of the labour force
- tastes of the labour force in terms of their trade-off between work and leisure
equation trade unions and bargaining power
Management costs of disagreeing (to union terms)/
Management costs of agreeing (to union terms)
Impact of trade unions:
- Restrict the supply of labour
* Collective bargaining
The bargaining strength of trade unions when dealing with employers increases when:
- The demand for the product is relatively inelastic
- The labour cost is a small proportion of the total cost
- A high level of profit is earned by the industry
- It is difficult to substitute between the factors of production
- The trade union is strong (e.g. high membership)
- The economic and political climate is favorable
monopsony
Employer associations created a monopoly on the demand side
Involves over 30 EU Directives seeking to establish minimum working conditions throughout the EU:
- Parental Leave Directive
- Working Hours Directive (max 48 hours)
- Part-time Workers Directive
- European Works Council Directive (transnational workers council)
- Information and Consultation Directive (already by 50 employees)
- Young Workers Directive (ban on under 15/ limits for under 18)
Economic rent:
The amount paid to a factor of production over and above that necessary to keep it in its present occupation
Transfer earning:
The minimum payment necessary to keep the factor of production in its present occupation
First-Degree Price Discrimination
occurs when a business charges the maximum possible price for each unit consumed
Second-Degree Price Discrimination
occurs when a company charges a different price for different quantities consumed
Third-Degree Price Discrimination
occurs when a company charges a different price to different consumer groups
