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ECON2001 Micro Theory > 4. The Theory of The Firm > Flashcards

4. The Theory of The Firm Flashcards

1
Q

Why do firms exist?

A
  • economies of scale
  • more efficient risk sharing
  • reduction in transaction costs
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2
Q

Technology

A

The conversion of inputs into outputs

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3
Q

Isoquant

A

A way of showing how much of a good different combinations of capital and labour produce

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4
Q

Homogeneity

A

A production function is homogenous if an increase in all inputs leads to an increase in the output

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5
Q

Relating to homogeneity when does a production function show increasing returns to scale

A

When the degree of homogeneity is r>1

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6
Q

Relating to homogeneity when does a production function show constant returns to scale

A

When the degree of homogeneity is r=1

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7
Q

Relating to homogeneity when does a production function show decreasing returns to scale

A

When the degree of homogeneity is r<1

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8
Q

Marginal product

A

The amount output changes when we increase one input marginally

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9
Q

Marginal rate of technical substitution

A

The rate at which one factor must decrease so that the same level of productivity can be maintained when another factor is increased

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10
Q

What is the MRTS equal to?

A

MPL/ MPK

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11
Q

Isocost

A

Levels of K and L that incur a constant cost

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12
Q

Isoquant

A

Defines combinations that produce constant output

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13
Q

How can we work out the total cost?

A

Using the production function and W/r=MRTS we can derive expressions for K and L in terms of Y. Derive the optimal inputs given output and plug this into the cost function

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14
Q

Solution methods for profit max

A
  • Lagrange
  • substitution method
  • cost minimisation
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15
Q

When does an interior solution for profit max occur?

A

It exists if in the domain of K and L the price ratio W/r= MRTS

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16
Q

Perfectly competitive market

A

One in which the invisible hand operates unimpeded

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17
Q

Properties of competitive market

A
  • homogeneous good
  • buyers and sellers are price takers
  • no barriers to entry
  • complete information
  • firms are profit maximisers
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18
Q

What does the demand curve for a perfectly competitive firm look like and why?

A

Horizontal because firms are price takers

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19
Q

Where does a profit maximising firm produce in a perfectly competitive market?

A

Price=MC=MR=AR

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20
Q

When is marginal benefit equal to marginal cost

A

In perfect competition because P=MB and P=MC

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21
Q

Why do perfectly competitive firms make zero profits in the long run

A
  • there are profits in market in long run
  • other firms see this and enter because there are no barriers to entry
  • market supply increases so price falls until p=AR=AC
22
Q

What are the types of efficiency?

A
  • allocative efficiency
  • productive efficiency
  • consumer surplus
  • producer surplus
23
Q

Allocative efficiency

A

Also known as Pareto efficiency- it is impossible to make someone better off without making someone else worse off

24
Q

Productive efficiency

A

When output is produced at lowest cost per unit, occurs if q is at minimum of the average cost curve

25
Q

Consumer surplus

A

The difference between amount consumers are willing to pay and what they actually paid

26
Q

Producer surplus

A

Difference between amount producer receives and the amount they are willing to accept

27
Q

What is the short run?

A

The period where at least one factor of input is fixed

28
Q

Long run

A

When all inputs can be varied

29
Q

Monopolistic competition

A

One seller and many buyers

30
Q

Properties of monopoly

A

Firms are price makers

Would expect a downward sloping demand curve

31
Q

1st degree price discrimination

A

The monopolist knows exactly his much the consumer is willing to pay and charges this amount

32
Q

2nd degree price discrimination

A

Selling of excess capacity, consumers self select into different groups

33
Q

3rd degree price discrimination

A

Firms offer different linear prices to different exogenous groups of consumers

34
Q

Benefits of price discrimination for consumers

A
  • could experience net welfare gain as a result of cross subsidisation
  • some consumers who previously couldn’t afford the good now can
  • could lead to new products since firms can invest their increased profits
35
Q

Which type of price discrimination is Pareto efficient?

A

1st degree, total surplus is maximised which means it is Pareto efficient

36
Q

Why must price discrimination schemes be incentive compatible?

A

The consumers must prefer to get the offered product to everything else or they won’t buy it

37
Q

Oligopolistic competition

A

A finite number of firms with same market power

38
Q

What does the nature of oligopolistic competition depend on?

A
  • whether the firms set p or q
  • whether they move simultaneously or sequentially
  • whether the game is one shot or repeated
39
Q

If oligopolistic competition is simultaneous and price is set what theory do we use?

A

Bertrand

40
Q

If oligopolistic competition is sequential and price is set what theory do we use?

A

Bertrand

41
Q

If oligopolistic competition is simultaneous and quantity is set what theory do we use?

A

Cournet

42
Q

If oligopolistic competition is sequential and quantity is set what theory do we use?

A

Stackelberg

43
Q

What happens in a duopoly with infinite price options which the firm can choose?

A

There is a unique NE at P1=P2=c

44
Q

What happens in a duopoly with monopoly or marginal cost price options which the firm can choose?

A

There are two NE’s at (Pm,Pm) and (Pc,Pc)

45
Q

What happens to the NE in a duopoly as N increases?

A

As the number of price strategies increases, the only possible NE is (Pc,Pc)

46
Q

How does adding a third player as consumer with search costs impact the Bertrand competition?

A

There is one pure strategy NE at (Pm,Pm, doesn’t check prices). This holds even if we increase the number of price strategies to infinity

47
Q

How do we solve for cournot competition when we have a duopoly?

A

Each agent maximises profit conditional on other agents strategy. This gives us a BR1(q2) and BR2(q1). The NE is the intersection of the best response functions

48
Q

How do we solve stackelberg problems?

A

We solve by backwards induction to find BR2(q1). We solve for q1 and then plug solution into BR2(q1) to find q2

49
Q

What is dynamic competition?

A

Where profits are discounted over time

50
Q

When does a grim trigger strategy have a sustained equilibrium in dynamic competition?

A

Only in infinite time and if the discount factor is >1/2

51
Q

In a boom and bust cycle for dynamic competition when is there more incentive to deviate?

A

In booms, therefore firms need to value the future more (have a greater discount factor)

ECON2001 Micro Theory (4 decks)

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